10-K/A 1 pfc10ka04.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A-#2 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------ ------------ Commission File Number 000-27437 PARAGON FINANCIAL CORPORATION ----------------------------- (Exact name of registrant as specified in its charter) Delaware 94-3227733 -------- ---------- (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) 2207 Sawgrass Village Drive 32082 --------------------------- ----- Ponte Vedra Beach, FL (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (904) 285-0000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.0001 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes |_| No |X| The aggregate market value of common stock held by non-affiliates of the Registrant on June 30, 2004 was approximately $1,490,850 based upon the closing sales price for our common stock on such date of $0.05 per share as reported on such date by the Nasdaq Over-The-Counter Bulletin Board. In making this calculation, the Registrant has assumed, without admitting for any other purpose, that all executive officers and directors of the Registrant are affiliates. As of March 23, 2005, the Registrant had 85,860,249 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE PART III incorporates information by reference from the Registrant's definitive Proxy Statement for its 2005 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2004. EXPLANATORY NOTE This Form 10-K/A #2 (the "Amendment") amends our Form 10-K for the year ended December 31, 2004, which was filed with the Securities and Exchange Commission on April 18, 2005 (the "Original Filing"). We are filing this Form 10-KSB/A to amend the Financial Statements. In connection with the filing of this Form 10-K/A #2 and pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, we are including with this Form 10-K/A #2 certain currently dated certifications. This Amendment does not reflect events occurring after the Original Filing except as noted above. Except for the foregoing amended information, this Form 10-K/A #2 continues to speak as of the date of the Original Filing and the Company has not otherwise updated disclosures contained therein or herein to reflect events that occurred at a later date.
TABLE OF CONTENTS Page ---- PART I Item 1. Business 1 Item 2. Properties 10 Item 3. Legal Proceedings. 10 Item 4. Submission of Matters to a Vote of Security Holders 11 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchase of Equity Securities 11 Item 6. Selected Financial Data 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results 12 of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk 21 Item 8. Financial Statements and Supplementary Data 22 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 22 Item 9A. Controls and Procedures 22 Item 9B. Other Information 22 PART III Item 10. Directors and Executive Officers of the Registrant 22 Item 11. Executive Compensation 25 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 28 Item 13. Certain Relationships and Related Transactions 29 Item 14. Principal Accountant Fees and Services 30 PART IV Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K 30 SIGNATURES 32 NOTE: Unless otherwise designated, all dollar amounts are in $000s, except per share amounts.
PART I FORWARD LOOKING STATEMENTS We believe that it is important to communicate our expectations to our investors. Accordingly, this report contains discussions of events or results that have not yet occurred or been realized. You can identify this type of discussion, which is often termed "forward-looking statements", by such words and phrases as "will", "explore", "consider", "continue", "expects", "anticipates", "intends", "plans", "believes", "estimates" and "could be". You should read forward-looking statements carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial position, or state other expectations of future performance. There may be events in the future that we are not able accurately to predict or control. Any cautionary language in this report provides examples of risks, uncertainties and events that may cause our actual results to differ from the expectations we express in our forward-looking statements. You should be aware that the occurrence of certain of the events described in this report could adversely affect our business, results of operations and financial position. These forward looking statements are based on information available to us on the date hereof, and we assume no obligation to update any such forward looking statement. It is important to note that our actual results and timing of certain events could differ materially from those in such forward looking statements due to a number of factors, including but not limited to, the ability to raise capital necessary to sustain operations and implement the business plan, the ability to obtain additional regulatory permits and approvals to operate in the financial services area, the ability to identify and complete acquisitions and successfully integrate acquired businesses, if any, the ability to implement our business plan, changes in the real estate market, interest rates or the general economy of the markets in which we operate, the ability to employ and retain qualified management and employees, changes in government regulations that are applicable to our businesses, the general volatility of the capital markets and the establishment of a market for our shares, changes in the demand for our services, our ability to meet our projections, the degree and nature of competitors, the ability to generate sufficient cash to pay creditors, and disruption in the economic and financial conditions primarily from the impact of past terrorist attacks in the United States, threats of future attacks, police and military activities overseas and other disruptive worldwide political events. Other risk factors that could cause actual results to differ materially are set forth in this item under the heading "Management Discussion and Analysis of Financial Condition and Results of Operations -- Overview" on page 15. ITEM 1. BUSINESS. General ------- We are a financial services company focused on acquiring mortgage origination companies that broker mortgage products in the one-to-four family residential mortgage market. We focus primarily on offering mortgage products to borrowers who generally satisfy the credit, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac (referred to as conforming loans). We originate these loans in accordance with the underwriting guidelines of those lenders. We currently conduct business in 2 states. Our executive offices are located in Ponte Vedra Beach, Florida. We were incorporated in Delaware in August 1999 under the name PRX Holdings, Inc. Our mortgage operations were acquired by us in January 2003. Our mortgage loan origination business is comprised of 19 loan officers. We broker the loans we originate to third party lenders. In 2003, we placed 85% of the mortgages we brokered with 2 particular lenders to receive the highest level of execution. Until January 2005, our loan officers were based in Florida, and 100% of our brokered loan volume relates to real property located in Florida. In 2004, 82.7% of the loans that we originated were for the purchase of residential property and 17.3% were refinances of existing mortgages. In 2003, 84.6% of the loans that we originated were for the purchase of residential property and 15.4% were refinances of existing mortgages. In 2004 and 2003, all of the loans we originated were secured by owner-occupied properties. 1 Company History We originally operated as an online healthcare destination under the name PlanetRX.com. In mid-2001 we began the process of liquidating our online health store and seeking a merger partner as an alternative to complete liquidation. On May 31, 2002, the Company merged with Paragon Homefunding, Inc. ("Paragon Delaware"), a privately held development stage company based in Ponte Vedra Beach, Florida, formed for the purpose of entering the financial services market through acquisitions. Paragon Delaware was incorporated in Delaware on August 3, 2001. For financial reporting purposes, the merger has been accounted for as a recapitalization of Paragon Delaware with Paragon Delaware viewed as the accounting acquiror in what is commonly called a reverse acquisition. Accordingly, the financial statements presented before the merger are those of Paragon Delaware. As a result of the merger, a new board of directors was elected and new officers were appointed. On December 26, 2002, we changed our name to Paragon Financial Corporation ("PFC"). On January 31, 2003, we completed our acquisition of Mortgage Express, Inc. (now known as PGNF Home Lending Corp.) ("PGNF"). PGNF was a mortgage bank focused on the wholesale sub-prime credit market. On May 31, 2004, we divested PGNF and exited the mortgage banking business. PGNF is shown as discontinued operations in the "Management Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 15, our financial statements beginning on page F-1, and elsewhere in this Form 10-K. On February 4, 2003, we completed the acquisition of Paragon Homefunding, Inc. ("PHF"), a Florida corporation focused primarily on the brokering of conforming loans. PHF represents our continuing operations in the "Management Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 15, our financial statements beginning on page F-1, and elsewhere in this Form 10-K. On January 19, 2005, we completed the acquisition of First Charleston Mortgage LLC ("FCM"), a South Carolina limited liability company focused primarily on the brokering of conforming loans. Growth and Operating Strategies We plan to pursue several strategies to increase revenue and profitability. These strategies include: (i) increasing loan origination volume, (ii) streamlining business processes through the deployment of technology, (iii) diversifying product offerings, and (iv) pursuing acquisitions. The key tactics for pursuing these strategies include: - Increasing loan origination volume: We intend to increase loan origination volume through geographic expansion on the East and West Coasts as well as increase market penetration in existing markets. We plan to continue to grow our production volume and market share by growing our branch network of wholly-owned brokers. - Streamlining business processes through the deployment of technology: We intend to continue our best practices initiative to streamline our business processes and use technology to drive loan origination and administrative costs lower and provide better service to our customers. - Diversifying product offerings: We plan to develop a broad range of products that are desirable in the markets that we compete. We intend to underwrite these products to our own underwriting guidelines. - Pursuing acquisitions: We intend to pursue an active acquisition strategy of accretive acquisitions of mortgage brokerage firms. We will also evaluate and pursue other new business opportunities and relationships in the marketplace in businesses ancillary to our mortgage origination business. 2 Product Types We broker a broad range of mortgage products that include both fixed-rate loans and adjustable-rate loans, or ARMs. In addition, these products are available at different interest rates and with different origination and application points and fees depending on the particular borrower's risk classification. Borrowers may choose to increase or decrease their interest rate through the payment of different levels of origination fees. The maximum loan amount is generally $500 with a loan-to-value ratio of up to 80%. We do, however, broker larger loans with higher loan-to-value ratios through special jumbo programs offered by lenders. During 2004, the average loan amount was approximately $167 compared to $145 in 2003. Loan Originations We originate loans directly to consumers through our loan officers located in our offices in Florida and South Carolina. Leads are generated through radio, direct mail, referrals and the internet. We originated a total of $86.4 million in mortgage loans for the twelve months ended December 31, 2004 compared to $79.9 million for the eleven month period that we owned PHF in 2003. Geographic Distribution In 2004 and 2003, all of our mortgage loans originated by our continuing operations were originated by PHF in Florida. Competition We continue to face intense competition in the business of originating mortgage loans. Our competitors include other mortgage brokering companies, mortgage banking companies, consumer finance companies, commercial banks, credit unions, thrift institutions, credit card issuers and insurance finance companies. Federally chartered banks and thrifts can preempt some of the state and local lending laws to which we are subject, thereby giving them a competitive advantage. In addition, many of these competitors have considerably greater technical and marketing resources than we have. Competition among industry participants can take many forms, including convenience in obtaining a loan, customer service, marketing and distribution channels, amount and term of the loan, loan origination fees and interest rates. Additional competition may lower the rates we can charge borrowers, thereby potentially lowering gain on future loan sales. Regulation Our business is regulated by federal, state, and local government authorities and is subject to extensive federal, state and local laws, rules and regulations. We are also subject to judicial and administrative decisions that impose requirements and restrictions on our business. At the federal level, these laws and regulations include the: Equal Credit Opportunity Act; Federal Truth and Lending Act and Regulation Z; Home Ownership and Equity Protection Act; Real Estate Settlement Procedures Act; Fair Credit Reporting Act; Fair Debt Collection Practices Act; Home Mortgage Disclosure Act; Fair Housing Act; Telephone Consumer Protection Act; Gramm-Leach-Bliley Act; Fair and Accurate Credit Transactions Act; CAN-SPAM Act; Sarbanes-Oxley Act; and USA PATRIOT Act. These laws, rules and regulations, among other things: impose licensing obligations and financial requirements on us; limit the interest rates, finance charges, and other fees that we may charge; prohibit discrimination; impose underwriting requirements; mandate disclosures and notices to consumers; mandate the collection and reporting of statistical data regarding our customers; regulate our marketing techniques and practices; require us to safeguard non-public information about our customers; regulate our collection practices; require us to prevent money-laundering or doing business with suspected terrorists; and impose corporate governance, internal control and financial reporting obligations and standards. 3 Our failure to comply with these laws can lead to: civil and criminal liability; loss of approved status; demands for indemnification or loan repurchases from buyers of our loans; class action lawsuits; and administrative enforcement actions. Compliance, Quality Control and Quality Assurance We regularly monitor the laws, rules and regulations that apply to our business and analyze any changes to them. We also maintain policies and procedures to help our origination personnel comply with these laws. Our training programs are designed to teach our personnel about the significant laws, rules and regulations that affect their job responsibilities. We also maintain a variety of pre-funding quality control procedures designed to detect compliance errors prior to brokering a loan. Licensing As of March 31, 2005, we were licensed to originate mortgages in the states of Florida and South Carolina. Environmental In the course of our business, we may acquire properties securing loans that are in default. There is a risk that hazardous or toxic waste could be found on such properties. If this occurs, we could be held responsible under applicable law for the cost of cleaning up or removing the hazardous waste. This cost could exceed the value of the underlying properties. Employees The table below presents our employees at March 15, 2005: Loan officers 19 Loan processors 4 Administrative personnel 6 Corporate 2 ------------ Total 31 ------------ Available Information Through our website (www.pgnf.com), we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Section 16 reports and any amendments to those reports as soon as reasonably practicable after such reports or amendments are electronically filed with or furnished to the Securities and Exchange Commission. Risk Factors Stockholders and prospective purchasers of our common stock should carefully consider the risks described below before making a decision to buy our common stock. If any of the following risks actually occurs, our business could be harmed. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. When determining whether to buy our common stock, stockholders and prospective purchasers should also refer to the other information in this Form 10-K, including our financial statements and the related notes. 4 We have incurred losses since our inception. As shown in the accompanying consolidated financial statements beginning on page F-1, we incurred a net loss of $5,897 for the year ended December 31, 2004 and cumulative losses of $9,861 since our inception (August 3, 2001). At December 31, 2004, our liabilities exceeded our assets by $2,948. These factors raise substantial doubt about our ability to continue as a going concern. Our continued existence depends on a number of factors, including but not limited to our ability to originate loans profitably, to secure adequate sources of capital and to locate and fund acquisitions of suitable companies. However, there can be no assurance that we will be successful in our endeavors and be able to continue as a going concern. Risks Related to Our Business An increase in interest rates could result in a reduction in our loan brokerage volumes, an increase in first payment defaults on loans we brokered, and a reduction in the revenue per loan brokered. The following are some of the risks we face related to an increase in interest rates: - A substantial and sustained increase in interest rates could harm our ability to originate loans because refinancing an existing loan would be less attractive and qualifying for a purchase loan may be more difficult; and - If prevailing interest rates increase after we receive a commitment to fund a loan, the value that we receive upon brokering of the loan decreases. Our business may be significantly harmed by a slowdown in the economy of Florida, where we conduct a significant amount of business. Since the acquisition of PHF, most of the mortgage loans we have brokered have been secured by property in the state of Florida. A decline in the economy or the residential real estate market in Florida could restrict our ability to broker loans, and significantly harm our business, financial condition, liquidity and results of operations. Our business may be significantly harmed by the weather in markets where we conduct a significant amount of business. In 2004, our PHF subsidiary saw a significant reduction in mortgage loans due to the hurricanes that affected the state of Florida. Hurricanes and other natural phenomena could hurt the real estate markets in which we operate and restrict our ability to originate loans. This would significantly harm our business, financial condition, liquidity and results of operations. We face intense competition that could adversely impact our market share and our revenue. We face intense competition from other financial and mortgage companies, internet-based lending companies where entry barriers are relatively low, and from traditional bank and thrift lenders to the mortgage industry. As we seek to expand our business further, we will face a significant number of additional competitors, many of whom will be well-established in the markets we seek to penetrate. Some of our competitors are much larger, have better name recognition, and have far greater financial and other resources than us. 5 The government-sponsored entities Fannie Mae and Freddie Mac are also expanding their participation in the mortgage industry. These government-sponsored entities have a size and cost-of-funds advantage that allows them to purchase loans with lower rates or fees than we are willing to offer. While the government-sponsored entities presently do not have the legal authority to originate mortgage loans, they do have the authority to buy loans. A material expansion of their involvement in the market to purchase loans could change the dynamics of the industry by virtue of their sheer size, pricing power and the inherent advantages of a government charter. In addition, if as a result of their purchasing practices, these government-sponsored entities experience significantly higher-than-expected losses, such experience could adversely affect the overall investor perception of the mortgage industry. The intense competition in the mortgage industry has also led to rapid technological developments, evolving industry standards and frequent releases of new products and enhancements. As mortgage products are offered more widely through alternative distribution channels, such as the internet, we may be required to make significant changes to our current retail operations and information systems to compete effectively. Our inability to continue enhancing our current capabilities, or to adapt to other technological changes in the industry, could significantly harm our business, financial condition, liquidity and results of operations. Competition in the industry can take many forms, including interest rates and costs of a loan, less stringent underwriting standards, convenience in obtaining a loan, customer service, amount and term of a loan and marketing and distribution channels. The need to maintain mortgage loan volume in this competitive environment creates a risk of price competition in the mortgage industry. Price competition could cause us to lower the interest rates that we offer borrowers, which could lower the value of our loans. If our competitors adopt less stringent underwriting standards we will be pressured to do so as well, which would result in greater loan risk without compensating pricing. If we do not relax underwriting standards in response to our competitors, we may lose market share. Any increase in these pricing and underwriting pressures could reduce the volume of our loan originations and sales and significantly harm our business, financial condition, liquidity and results of operations. Defective loans may harm our business. In connection with the origination of loans, we are required to make a variety of customary representations and warranties regarding the loans we originate, primarily related to fraud on the application and first payment defaults. These representations and warranties relate to, among other things, compliance with laws; regulations and underwriting standards; the accuracy of information in the loan documents and loan file; and the characteristics and enforceability of the loan. We are subject to losses due to fraudulent and negligent acts on the part of loan applicants, mortgage brokers, other vendors and our employees. When we originate mortgage loans, we rely heavily upon information supplied by third parties including the information contained in the loan application regarding employment and income history, property appraisal and title information. Whether a misrepresentation is made by the loan applicant, the mortgage broker, another third party or one of our own employees, we often bear the risk of loss associated with the misrepresentation. Even though we may have rights against persons and entities who made or knew about the misrepresentation, such persons and entities are often difficult to locate and it is often difficult to collect any monetary losses that we have suffered from them. Although we have controls and processes in place that are designed to identify misrepresented information in our loan origination operations, we cannot assure you that we have detected or will detect all misrepresented information in our loan originations. If we experience a significant number of such fraudulent or negligent acts, our business, financial condition, liquidity and results of operations could be significantly harmed. 6 The inability to attract and retain qualified employees could significantly harm our business. We depend upon our loan officers to attract borrowers, by, among other things, developing relationships with financial institutions, other mortgage companies, real estate agents, borrowers and others. We believe that these relationships lead to repeat and referral business. The market for skilled executive officers and loan officers is highly competitive and historically has experienced a high rate of turnover. In addition, if a manager leaves our company there is a likelihood that other members of his or her team will follow. Competition for qualified loan officers may lead to increased hiring and retention costs. Our inability to attract or retain a sufficient number of skilled loan officers and other key employees at manageable costs could harm our business. If we do not manage our growth effectively, our financial performance could be harmed. We have experienced substantial changes and rapid growth that place certain pressures on our management, administrative, operational and financial infrastructure. We expect to continue to experience this rapid growth both organically and through acquisitions. The increase in the size of our operations may make it more difficult for us to ensure that we originate quality loans. We will need to attract and hire additional sales and management personnel in an intensely competitive hiring environment in order to preserve and increase our market share. We will also need to effectively integrate our acquisitions. At the same time, we will need to continue to upgrade and expand our financial, operational and managerial systems and controls, which could require capital and human resources beyond what we currently have. We cannot assure you that we will be able to meet our capital needs; expand our systems effectively; allocate our human resources optimally; identify and hire qualified employees; or effectively integrate acquired businesses to achieve growth. The failure to manage growth or integrate acquisitions effectively would significantly harm our business, financial condition, liquidity and results of operations. An interruption in or breach of our information systems may result in lost business. We rely heavily upon communications and information systems to conduct our business. As we implement our growth strategy and increase our volume of loan production, that reliance will increase. Any failure or interruption or breach in security of our information systems or the third-party information systems on which we rely could cause underwriting or other delays and could result in fewer loan applications being received, slower processing of applications and reduced efficiency in loan servicing. We cannot assure you that such failures or interruptions will not occur or if they do occur that they will be adequately addressed by us or the third parties on which we rely. The occurrence of any failures or interruptions could significantly harm our business. The success and growth of our business will depend upon our ability to adapt to and implement technological changes. Our mortgage loan origination business is currently dependent upon our ability to effectively interface with our brokers, borrowers and other third parties and to efficiently process loan applications and closings. The origination process is becoming more dependent upon technological advancement, such as the ability to process applications over the Internet, accept electronic signatures, provide process status updates instantly and other customer-expected conveniences that are cost-efficient to our process. Implementing this new technology and becoming proficient with it may also require significant capital expenditures. As these requirements increase in the future, we will have to fully develop these technological capabilities to remain competitive or our business will be significantly harmed. Our financial results fluctuate as a result of seasonality and other timing factors, which makes it difficult to predict our future performance. Our business is generally subject to seasonal trends. These trends reflect the general pattern of housing sales, which typically peak during the spring and summer seasons. Our quarterly operating results have fluctuated in the past and are expected to fluctuate in the future, reflecting the seasonality of the industry. 7 In the future, our hedging strategies may not be successful in mitigating our risks associated with interest rates. Although we do not currently use various derivative financial instruments to provide a level of protection against interest rate risks, we may elect to do so in the future. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. Risks Associated with Our Acquisition Strategy There are risks associated with our acquisition strategy. We intend to continue to grow through internal expansion and by making selective acquisitions of small- to medium-sized mortgage brokers. We cannot predict whether we will be successful in pursuing these acquisitions or whether these acquisitions will provide us with positive operating results. Consummation of each acquisition is subject to various conditions, such as securing the approval of state licensing bodies. Acquisitions may involve a number of specific risks including adverse short-term effects on our results of operations, dilution from issuances of our common stock and strain on our financial and administrative infrastructure. Our acquisition strategy involves numerous other risks, including risks associated with: - Identifying acquisition candidates and negotiating definitive purchase agreements on satisfactory terms; - Conducting adequate due diligence; - Intergrating operations, personnel and management information systems; - Managing a growing and geographically diverse group of employees; - Diverting management's attention from other business concerns; and - Competition for attractive acquisition candidates from other acquirers. We cannot be certain that we will be able to successfully integrate our acquisitions or manage the resulting business effectively, or that any acquisition will achieve the benefits that we anticipate. In addition, we are not certain that we will be able to acquire companies at attractive valuations. Depending upon the nature, size and timing of potential future acquisitions, we may be required to raise additional financing in order to consummate additional acquisitions. We cannot assure you that our existing or future financing agreements will permit the necessary additional financing or that additional financing will be available to us or, if available, that financing would be on terms acceptable to our management. There are risks associated with our plan to use our common stock as acquisition consideration. We expect to finance future acquisitions primarily through issuing shares of our common stock for all or a portion of the consideration to be paid. In the event that our common stock does not maintain a sufficient market value, or potential acquisition candidates are otherwise unwilling to accept our common stock as part of the consideration for the sale of their businesses, our ability to issue common stock as acquisition consideration may be limited. In addition, currently our stock is thinly traded on the NASDAQ OTC Bulletin Board. This lack of liquidity may discourage some acquisition candidates from accepting our common stock as acquisition consideration. 8 Statutory and Regulatory Risks The multi-state scope of our operations exposes us to risks of noncompliance with an increasing and inconsistent body of complex laws and regulations at the federal, state and local levels. We are currently licensed or exempt from licensing, in 2 states and must comply with the laws and regulations, as well as judicial and administrative decisions, of these jurisdictions, as well as an extensive body of federal laws and regulations. The volume of new or modified laws and regulations has increased in recent years. The laws and regulations of each of these jurisdictions are different, complex and, in some cases, in direct conflict with each other. As our operations continue to grow to include other states, it may be more difficult to comprehensively identify, to accurately interpret and to properly program our technology systems and effectively train our personnel with respect to all of these laws and regulations, thereby potentially increasing our exposure to the risks of noncompliance with these laws and regulations. Increased regulation would result in increased compliance costs. Our failure to comply with these laws can lead to civil and criminal liability; loss of our licenses and right to do business in the various states; class action lawsuits; and administrative enforcement actions. Several federal, state and local laws and regulations have been adopted or are under consideration intended to eliminate so-called "predatory" lending practices. Many of these laws and regulations impose broad restrictions on certain commonly accepted lending practices, including some of our practices. There can be no assurance that these proposed laws, rules and regulations, or other similar laws, rules or regulations, will not be adopted in the future. Adoption of these laws and regulations could have a material adverse impact on our business by substantially increasing the costs of compliance with a variety of inconsistent federal, state and local rules, or by restricting our ability to charge rates and fees adequate to compensate us for the risk associated with certain loans. The increased governmental scrutiny of Fannie Mae and Freddie Mac may also result in regulatory changes and oversight which may have an adverse impact on the industry generally, and in turn have a negative effect on our business. Stockholder refusal to comply with regulatory requirements may interfere with our ability to do business in certain states. Some states in which we operate may impose regulatory requirements on our officers and directors and persons holding certain amounts of our common stock, usually 10% holders. If any of these persons fails to meet or refuses to comply with a state's applicable regulatory requirements for licensing, we could lose our authority to conduct business in that state. We may be unable to compete effectively with financial institutions that are exempt from certain state restrictions. Certain federally chartered financial institutions are exempt from the state laws to which we are subject and may operate more effectively under the federal laws that govern their operations. The increasing number of federal, state and local "anti-predatory lending" laws may restrict our ability to originate or increase our risk of liability with respect to certain mortgage loans and could increase our cost of doing business. The continued enactment of these laws, rules and regulations may prevent us from making certain loans and may cause us to reduce the APR or the points and fees on loans that we do make. If nothing else, the growing number of these laws, rules and regulations will increase our cost of doing business as we are required to develop systems and procedures to ensure that we do not violate any aspect of these new requirements. Any of the foregoing could significantly harm our business, financial condition, liquidity and results of operations. 9 ITEM 2. PROPERTIES Our executive office is located at 2207 Sawgrass Village Drive, Ponte Vedra Beach, Florida. We presently occupy approximately 348 square feet of space at this location and pay no annual rent on our executive office. Our PHF subsidiary occupies approximately 2,500 square feet in Maitland, Florida under a lease expiring March 31, 2006. The annual rent on our office in Maitland, Florida is $52, with an escalator clause based on CPI. ITEM 3. LEGAL PROCEEDINGS On September 24, 2004, the Company defaulted on its promissory note dated June 4, 2003 to Bank of America, N.A. ("BoA") being unable to repay this note in full when demanded to do so by BoA. BoA commenced legal action against us and other guarantors of the indebtedness for repayment. On December 13, 2004, we entered into a standstill agreement with BoA whereby, for a principal reduction payment of $25 and the payment of an extension fee and BoA's legal fees, the maturity date of the note was extended to December 1, 2005, the interest rate was increased to the bank's prime rate plus 4%, and requires principal reduction payments of $5 per month through November 1, 2005. On October 15, 2004, we were served with a summons on an eviction action of our executive offices by our landlord seeking unpaid rent and other damages of $268. We agreed to vacate the office space we occupied in forgiveness of unpaid rents under the lease and forfeiture of our deposit of $25. Based upon this agreement, the action was dismissed with prejudice. In mid-2001, the Company, and certain of its former directors and officers were named as defendants in class action complaints alleging violations of the federal securities laws in the United States District Court for the Southern District of New York. In mid-2002, the complaints against the Company were consolidated into a single action. The essence of the complaint is that in connection with the Company's initial public offering in October 1999 ("IPO"), the defendants issued and sold the Company's common stock pursuant to a registration statement which did not disclose to investors that certain underwriters in the offering had solicited and received excessive and undisclosed commissions from certain investors acquiring the Company's common stock in connection with the IPO. The complaint also alleges that the registration statement failed to disclose that the underwriters allocated Company shares in the IPO to customers of the underwriters in exchange for the customers' promises to purchase additional shares in the aftermarket at pre-determined prices above the IPO price. The action seeks damages in an unspecified amount. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies that had initial public offerings of securities between 1997 and 2000 same time period. The Company has approved a Memorandum of Understanding ("MOU") and related agreements which set forth the terms of a settlement between the Company, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement contemplated by the MOU provides for a release of the Company and the individual defendants for the conduct alleged in the action to be wrongful. The Company would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. It is anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, the Company does not expect that the settlement will involve any payment by the Company. The MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the Court. We cannot opine as to whether or when a settlement will occur or be finalized. Whether or not the settlement is ultimately approved, we believe the resolution of this matter will not have a material adverse effect on the Company. 10 We are also party to various legal proceedings arising out of the ordinary course of our business. Management believes that any liability with respect to these legal actions, individually or in the aggregate, will not have a material adverse effect on our consolidated financial position and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 2004. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock trades in the over-the-counter market and is quoted on the OTC Bulletin Board under the symbol PGNF. As of March 23, 2005, we had 85,860,249 shares of common stock issued and outstanding, respectively. The following table sets forth, for the periods indicated, the high and low bid prices per share of our common stock as quoted on the OTC Bulletin Board.
High Low ---- --- 2005 1st Quarter through March 23, 2005 $ 0.09 $ 0.03 2004 4th Quarter $ 0.17 $ 0.04 3rd Quarter $ 0.15 $ 0.04 2nd Quarter $ 0.14 $ 0.04 1st Quarter $ 0.34 $ 0.10 2003 4th Quarter $ 0.52 $ 0.15 3rd Quarter $ 0.62 $ 0.44 2nd Quarter $ 0.75 $ 0.45 1st Quarter $ 0.80 $ 0.40
Holders As of March 23, 2005, we had approximately 326 stockholders of record. Only record holders of shares held in "nominee" or street names are included in this number. Dividends We have never declared or paid cash dividends on our common stock. We intend to retain future earnings, if any, for use in the operations of our business including working capital, repayment of indebtedness, capital expenditures and general corporate purposes. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. 11 Equity Compensation Plan Information Information regarding our equity compensation plans, including both stockholder approved plans and non-stockholder approved plans, is included in Item 12. Recent Sales of Unregistered Securities During the fourth quarter of 2004, we issued 300,000 restricted shares valued at $17 (or $0.06 per share) under our 2002 Equity Participation Plan to consultants for services during the fourth quarter of 2004, 221,000 shares valued at $11 (or $0.05 per share) to vendors in settlement of certain outstanding obligations, and 625,000 shares valued at $25 (or $0.04 per share) to a director for director fees. ITEM 6. SELECTED FINANCIAL DATA The table below sets forth a summary of our results of operations and financial condition as of and for the periods then ended for our continuing operations. This information has been derived from our audited consolidated financial statements contained elsewhere in this report. Such selected financial data should be read in conjunction with those financial statements and the notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" also included elsewhere herein.
Twelve months ended December 31 Inception to December 31 2004 2003 2002 2001 ---- ---- ---- ---- Statement of operations data: Total revenues $ 2,034 $ 1,964 $ -- $ -- Total operating expenses $ 3,712 $ 4,066 $ 2,337 $ 225 Interest expense $ 107 $ 415 $ 5 $ -- Loss from continuing operations $ (2,358) $ (1,680) $ (2,342) $ (225) Loss from continuing operations per common share $ (0.03) $ (0.01) $ (0.04) $ (0.01) Balance sheet data: Total assets $ 257 $ 35,662 $ 206 $ -- Total liabilities $ 3,205 $ 27,686 $ 1,074 $ 197 Stockholders' (deficit) equity $ (2,948) $ 7,976 $ (868) $ (197) Tangible net worth $ (2,948) $ (660) $ (868) $ (197)
As mentioned elsewhere, prior to our acquisitions of PGNF and PHF, we were a development stage enterprise and had no revenues. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes contained elsewhere herein. 12 General ------- We are headquartered in Ponte Vedra Beach, Florida and were incorporated in Delaware in August 1999. We are a financial services company focused on the acquisition of mortgage brokers in the one-to-four family residential mortgage market. We conduct business in 3 states. Overview -------- Our business relies on our ability to originate mortgage loans at a reasonable cost. The mortgage industry is generally subject to seasonal trends, and loan origination volumes in our industry have historically fluctuated from year to year and are affected by such external factors as home values, the level of consumer debt and the overall condition of the economy. In addition, the premiums we receive from the secondary market for our loans have also fluctuated, also influenced by the overall condition of the economy and, more importantly, the interest rate environment. As a consequence, the business of originating and selling loans is cyclical. Critical Accounting Policies ---------------------------- We have established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our financial statements. Certain accounting policies require us to make significant estimates and assumptions that may have a material impact on certain assets and liabilities, as well as our operating results, and we consider these to be critical accounting policies. The estimates and assumptions we use are based on historical experience and other factors which we believe to be reasonable under the circumstances. Actual results, particularly goodwill and loss of our discontinued segment, could differ materially from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities and our results of operations. We believe the following critical accounting policies require the most significant estimates and assumptions that are subject to significant change in the preparation of our consolidated financial statements: Origination Fees ---------------- Origination fees are comprised of points and other fees charged on mortgage loans originated by our loan officers and brokered through other banks and financial institutions. Points and fees are primarily a function of the volume of mortgage loans originated by our loan officers. Loan Origination Costs ---------------------- We also measure and monitor the cost to originate our loans. Such costs include the points and fees we may pay to our loan officers, net of fees we receive from borrowers, plus our operating expenses associated with the loan origination business. Income Taxes ------------ We file a consolidated federal income and combined state franchise tax returns. We utilize the asset and liability method of accounting for income taxes, under which deferred taxes are recognized for the future tax consequences attributable to the differences between the financial statement values of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates we expect to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred taxes of a change in tax rates in income in the period that includes the enactment date. 13 In determining the possible realization of deferred tax assets, we consider future taxable income from the following sources: (a) the reversal of taxable temporary differences, (b) future operations exclusive of reversing temporary differences, and (c) tax planning strategies that, if necessary, would be implemented to accelerate taxable income into periods in which net operating losses might otherwise expire. Subsequent to the year ended December 31, 2004, we determined to reduce the carrying value of deferred tax assets to $0 by increasing the deferred tax valuation allowance $414 (see Note 17 of Notes to Consolidated Financial Statements). Discontinued Operations ----------------------- In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144), a component classified as held for sale is reported in discontinued operations when the following conditions are met: (a) the operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction and (b) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. In a period in which a component of an entity either has been disposed of or is classified as held for sale, the income statement for current and prior periods reports the results of operations of the component, including any gain or loss recognized in accordance with SFAS 144 paragraph 37, in discontinued operations. The results of discontinued operations, less applicable income taxes (benefit), is reported as a separate component of income before extraordinary items and the cumulative effect of accounting changes (if applicable). The assets and liabilities of a disposal group classified as held for sale is presented separately in the asset and liability sections, respectively, of the statement of financial position. Results of Operations --------------------- Until our acquisitions of PGNF and PHF, we were a development stage enterprise and had no revenues. The following table sets forth our results of operations as a percentage of total revenues for our continuing operations for the years ended December 31, 2004 and 2003:
2004 2003 ---- ---- Revenue: Loan origination fees 100.0% 100.0% ------ ------ Total revenue 100.0% 100.0% Expenses: Salaries, commissions, and benefits 94.2% 128.2% Loan production costs 4.5% 5.2% General and administrative expenses 42.2% 56.7% Impairment of goodwill 40.4% -- 1.2% 17.0% ------ ------ Total expenses 182.5% 207.1% ------ ------ Operating loss (82.5)% (107.1)% Other expense: Interest expense 5.3% 21.1% Loss on sale of assets 0.7% 0.0% Loss on disposal of segment 5.0% 0.0% ------ ------ Loss from continuing operations before provision (benefit) for income taxes (93.5)% (128.2)% Provision (benefit) for income taxes 22.4% (42.7) ------ ------ Net loss from continuing operations (115.9)% (85.5)% ====== ======
14 Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Loan Originations: We originated $86.4 million in mortgage loans for the year ended December 31, 2004 compared to $79.9 million for the year ended December 31, 2003. This increase in loan originations was due primarily to the loan originations in 2003 representing only the eleven months we owned our PHF subsidiary. Revenues -------- Revenue from loan closings. Revenue from loan closings increased $70, or 3.6%, to $2,034 for the year ended December 31, 2004 compared to $1,964 for the year ended December 31, 2003. These fees represent points and other fees charged on mortgage loans originated by our loan officers. This increase in revenue from loan closings is due primarily to the revenue from loan closings in 2003 representing only the eleven months we owned our PHF subsidiary. Expressed in terms as revenue per loan, our revenues per loan increased $0.3, or 9.4%, to $3.9 per loan for the year ended December 31, 2004 compared to $3.6 per loan for the year ended December 31, 2003. Operating Expenses ------------------ Salaries, commissions and benefits. Salaries, commissions and benefits decreased $601, or 23.9%, to $1,916 for the year ended December 31, 2004 compared to $2,517 for the year ended December 31, 2003. This decrease was primarily due to a reduction in salaries at our corporate offices in the year ended December 31, 2004 compared to the year ended December 31, 2003. Loan production costs. Loan production costs decreased $12, or 11.7%, to $91 for the year ended December 31, 2004 compared to $103 for the year ended December 31, 2003. This decrease was due primarily to the higher pull through rate at our PHF subsidiary and reductions in costs associated with originating loans in the year ended December 31, 2004 compared to December 31, 2003. General and administrative expenses. General and administrative expenses decreased $255, or 22.9%, to $858 for the year ended December 31, 2004 compared to $1,113 for the year ended December 31, 2003. This decrease was primarily due to reduced operating expenses resulting at our corporate headquarters in the year ended December 31, 2004 compared to the year ended December 31, 2003. Impairment of goodwill. Subsequent to the year ended December 31, 2004, we recognized an impairment charge of $822 in connection with the value of goodwill. After the impairment charge, goodwill had a remaining book value of $0 (see Note 17 of Notes to the Consolidated Financial Statements). Non-recurring expenses. Non-recurring expenses decreased by $308, or 92.5%, to $25 for the year ended December 31, 2004 compared to $333 for the year ended December 31, 2003. For the year ended December 31, 2004, the non-recurring expenses relate to payments made for investment banking fees related to an unsuccessful financing effort. For the year ended December 31, 2003, the non-recurring expenses relate to severance for our former CEO and for investment banking fees and travel related to an unsuccessful financing effort. Operating loss. The operating loss decreased by $424, or 20.2%, to $1,678 for the year ended December 31, 2004 compared to $2,102 for the year ended December 31, 2003. This decrease was due primarily to factors discussed above. Interest expense. Interest expense decreased $308, or 74.2%, to $107 for the year ended December 31, 2004 compared to $415 for the year ended December 31, 2003. This decrease was due primarily to the beneficial conversion feature of our convertible debentures being amortized into interest expense in the year ended December 31, 2003. 15 Loss on sale of assets. Loss on the sale of assets was $15 for the year ended December 31, 2004. This loss related to the sale of office furniture and fixtures at our former corporate office location as part of a settlement of our lease obligation with the landlord. Loss on disposal of segment. Loss on the disposal of PGNF was $102 for the year ended December 31, 2004. This represents the non-cash loss we incurred in disposing of PGNF. Provision (benefit) for income taxes. The provision (benefit) for income taxes increased $1,293 to an expense of $456 for the year ended December 31, 2004 compared to a benefit of $(837) for the year ended December 31, 2003. This increase was primarily due to state income taxes applicable to our PHF subsidiary in 2004, which were not offset by our loss at our corporate office, and the recognition of an increase of $708 in the deferred tax asset valuation allowance. Net loss from continuing operations. The net loss from continuing operations increased by $678, or 40.4%, to $2,358 for the year ended December 31, 2004 compared to $1,680 for the year ended December 31, 2003. This increase was primarily due to $822 in impairment expense offset by the decreases in expenses, and increased deferred taxes, as discussed above. Loss from discontinued operations. The loss from discontinued operations increased $3,822, or 1,350.5%, to $3,539 for the year ended December 31, 2004 compared to income from discontinued operations of $283 for the year ended December 31, 2003. This decrease relates primarily to an impairment charge of $2,582 on the goodwill associated with the acquisition of PGNF incurred in the year ended December 31, 2004. Net loss. The net loss increased $4,500, or 322.1%, to $5,897 for the year ended December 31, 2004 compared to $1,397 for the year ended December 31, 2003. This increase was due to the factors discussed above. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Loan Originations: During the eleven months we owned PHF in 2003, it originated $79.9 million in mortgage loans. Revenues -------- Revenue from loan closings. Revenue from loan closings were $1,964 for the year ended December 31, 2003. These fees represent points and other fees charged on mortgage loans originated by our loan officers. The revenue from loan closings represents only the eleven months we owned our PHF subsidiary. For the year ended December 31, 2002, we were a development stage company and had no revenues. Operating Expenses ------------------ Salaries, commissions and benefits. Salaries, commissions and benefits increased $749, or 42.4%, to $2,517 for the year ended December 31, 2003 compared to $1,768 for the year ended December 31, 2002. This increase was due to the inclusion of the salaries, commission and benefits paid by our PHF subsidiary acquired on February 4, 2003 for the year ended December 31, 2003. Loan production costs. Loan production costs were $103 for the year ended December 31, 2003. These costs relate to costs incurred to originate mortgage loans by our PHF subsidiary acquired February 4, 2003. General and administrative expenses. General and administrative expenses increased $544, or 95.6%, to $1,113 for the year ended December 31, 2003 compared to $569 for the year ended December 31, 2002. This increase was due to a $330 increase in our operating expenses at our corporate headquarters and $214 in operating expenses for our PHF subsidiary acquired on February 4, 2003. 16 Non-recurring expenses. Non-recurring expenses were $333 for the year ended December 31, 2003 and consist of $240 in severance for our former CEO and $93 related to investment banking fees and travel related to an unsuccessful financing effort. Operating loss. The operating loss decreased by $235, or 10.1%, to $2,102 for the year ended December 31, 2003 compared to $2,337 for the year ended December 31, 2002. This decrease was due primarily to factors discussed above. Interest expense. Interest expense increased $410, or 8200.0%, to $415 for the year ended December 31, 2003 compared to $5 for the year ended December 31, 2002. This increase was due primarily to the beneficial conversion feature of our convertible debentures being amortized into interest expense in the year ended December 31, 2003. Benefit for income taxes. Benefit for income taxes was $837 for the year ended December 31, 2003 compared to $0 for the year ended December 31, 2002. This increase was due to our not providing a tax benefit related to net operating losses suffered in 2002 since we were a development stage company. Net loss from continuing operations. The net loss from continuing operations decreased $662, or 28.3%, to $1,680 for the year ended December 31, 2003 compared to $2,342 for the year ended December 31, 2002. This decrease was primarily due to the factors discussed above. Income from discontinued operations. The income from discontinued operations was $283 for the year ended December 31, 2003 and relates to our former PGNF subsidiary disposed of on May 31, 2004. PGNF was acquired on January 31, 2003 and was included in the results of our operations from that date. Net loss. The net loss decreased $945, or 40.4%, to $1,397 for the year ended December 31, 2003 compared to $2,342 for the year ended December 31, 2002. This decrease was due to the factors discussed above. Quarterly Results ----------------- Set forth below is certain unaudited quarterly financial data for each of our last eight quarters. The information has been derived from unaudited financial statements that, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary to fairly present such quarterly information in accordance with generally accepted accounting principles. The operating results for any quarter are not necessarily indicative of the results to be expected for any future period.
Year Ended December 31, 2004 (in thousands, except per share amount) First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Revenue $ 582 $ 637 $ 479 $ 336 Total operating expenses $ 1,043 $ 816 $ 549 $ 1,304 Interest expense $ 18 $ 25 $ 41 $ 23 Loss on disposal of segment and assets $ -- $ 102 $ -- $ 15 Loss from continuing operations $ (479) $ (306) $ (111) $ (1,462) Net loss $(3,352) $ (972) $ (111) $ (1,462) Basic and diluted loss per share $ (0.03) $ (0.01) $ (0.00) $ (0.03)
17 In connection with the audit of our financial statements as of and for the year ended December 31, 2003, we recognized an income tax benefit on our net operating loss. We had not recognized such a benefit in our previously reported quarterly information. In the table below, we have allocated this tax benefit to our previously reported quarterly information.
Year Ended December 31, 2003 (in thousands, except per share amount) First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Revenue $ 270 $ 545 $ 656 $ 493 Total operating expenses $ 571 $ 1,072 $ 1,031 $ 1,392 Interest expense $ 109 $ 100 $ 104 $ 102 Loss from continuing operations $ (410) $ (627) $ (479) $ (1,001) Net loss $ (923) $ (281) $ (84) $ (109) Basic and diluted loss per Share $ (0.01) $ (0.00) $ (0.00) $ (0.00)
Liquidity and Capital Resources ------------------------------- Our primary source of liquidity is from fees earned by originating mortgage loans. Our mortgage origination operations require continued access to cash to fund ongoing administrative, operating, and tax expenses as well as providing cash to fund our corporate operations. Our corporate operations require access to cash to fund ongoing administrative expenses, our acquisition program, tax expenses as well as interest and principal payments under our existing indebtedness. At December 31, 2004, we had cash and cash equivalents of approximately $135 and fees receivable of $46 with which to satisfy our on-going mortgage and corporate operation's current liabilities of $2,254. We deemed this liquidity level as insufficient to accomplish our goals and meet our liquidity needs for 2005, and we continued the implementation of our liquidity improvement plan. This plan includes: - Reducing our corporate operating expenses. - Raising equity capital - Acquiring profitable mortgage brokering operations producing positive cash flow. - Renegotiating the terms of our existing indebtedness with major creditors to defer material principal payments into the future. As part of this plan, we continued the reduction in the amount of cash required to fund our corporate operations which began in June 2004 following the divestiture of PGNF. We expect this reduction in corporate operating expenses will help us obtain profitability with fewer acquisitions needed and will reduce the dilution that would otherwise be required by having to raise a substantial amount of equity capital. On February 28, 2005, we completed a private placement financing transaction (the "Offering") pursuant to which we sold 17,207,791 units (at $0.0308 per unit) to several accredited investors for an aggregate purchase price of $530. Each unit consisted of one share of common stock, par value $0.0001 per share (the "Common Stock"), and one warrant to purchase one share of Common Stock at $0.04 per share expiring on December 31, 2007. This Offering increased our cash and cash equivalents by $342 subsequent to our year-end. On January 19, 2005, we acquired FCM, a South Carolina mortgage brokering company. On March 15, 2005, we announced that we had assumed operations of a branch of another mortgage origination company based in Jacksonville, Florida. We expect these operations to provide cash to fund our corporate operations during the quarter ended June 30, 2005. 18 We are actively discussing the restructuring of our debt with our creditors. Below is a summary of our actions to date attempting to restructure our debt. Short-term debt. On June 4, 2003, we entered into a revolving line of credit with a commercial bank in the amount of $250,000. This revolving line of credit had an interest rate of prime, is secured by a general lien on our assets, and is guaranteed by our current and former subsidiaries. The commercial bank demanded repayment of this credit facility on September 13, 2004. We were not able to meet this demand, and, as discussed elsewhere, we entered into a standstill agreement with this bank whereby the maturity date of the note was extended to December 1, 2005, the interest rate was increased to the bank's prime rate plus 4%, and requires principal reduction payments of $5 per month through November 1, 2005. Convertible debentures. On March 6, 2003, we completed a private offering of 379 units consisting of (i) a $1 convertible promissory note due December 31, 2003 with interest payable quarterly at a stated interest rate of 15% per annum and (ii) a warrant to purchase shares of common stock, exercisable at $0.25 per share, for each $5.00 in principal of the promissory note issued in the unit. The holder has the right to convert the outstanding principal amount of the convertible promissory note (or any portion thereof), together with accrued interest thereon, into shares of our common stock at a conversion price of $0.25 per share, subject to standard anti-dilution adjustments as specified in the note. In 2005, we repaid principal of $40 to certain holders of our 15% convertible notes and the remaining holders have agreed to amend the maturity date of the convertible notes to December 31, 2006 and reduce the interest rate thereon to 10% in consideration for a reduction in the strike price of the warrants to $0.05 per share. The convertible notes require quarterly interest payments on March 31, June 30, September 30, and December 31 of each year. Notes payable and liabilities to formerly related party: On April 7, 2005, the holder of notes with a face value of $1,531 and accrued interest of $46 agreed to accept monthly interest payments of approximately $7 in lieu of what is contractually due. There was no set timeframe within which the holder agreed to accept interest only payments. We anticipate working towards a formal standstill agreement with the holder, but we cannot be certain such an agreement will be reached. Accrued expenses - related parties: On February 28, 2005, certain of our former executives and current shareholders agreed in principal to convert amount currently due them into additional shares of our Series E Preferred Stock. The stated value of each share of the Series E Preferred is $1,000 per share; has a mandatory dividend of 4% of the stated value, per annum and shall be payable on January 1st of each year and is payable in either shares of the Company's common stock or cash; has no voting rights; and is not convertible. In addition to the above, we continue to explore additional ways to enhance our liquidity and reduce our insolvency risk. Recent Accounting Pronouncements -------------------------------- In January 2003, the FASB issued FIN 46(R), "Consolidation of Variable Interest Entities -- an interpretation of ARB No. 51" ("FIN 46(R)"). The objective of this Interpretation is not to restrict the use of variable interest entities but to improve financial reporting by enterprises involved with variable interest entities. FIN 46(R) states that a business enterprise with a controlling financial interest in a variable interest entity should include the assets, liabilities, and results of the activities of the variable interest entity in consolidated financial statements with those of the business enterprise. FIN 46(R) applied immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The adoption of this interpretation has had no effect on the Company's financial statements. 19 On December 12, 2003, the American Institute of Certified Public Accountants issued Statement of Position No. 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" (SOP 03-3). SOP 03-3 requires acquired impaired loans for which it is probable that the investor will be unable to collect all contractually required payments receivable to be recorded at the present value of amounts expected to be received and prohibits carrying over or creation of valuation allowances in the initial accounting for these loans. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. SOP 03-3 does not have an impact on the Company's results of operations or financial condition. In March 2004, Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 105 was issued, which provides guidance regarding loan commitments that are accounted for as derivative instruments under FASB No. 133 (as amended), "Accounting for Derivative Instruments and Hedging Activities". In this Bulletin, the SEC ruled that the amount of the expected servicing rights should not be included when determining the fair value of derivative interest rate lock commitments. This guidance must be applied to rate locks initiated after March 31, 2004. SAB No. 105 has had no impact on our financial condition or results of operations. In March, 2004, the Emerging Issues Task Force (EITF) issued EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-1). EITF 03-1 provides recognition and measurement guidance regarding when impairments of equity and debt securities are considered other-than-temporary thereby requiring a charge to earnings. EITF 03-1 also requires additional annual disclosures for investments in unrealized loss positions. The additional annual disclosure requirements were previously issued by the EITF in November 2003 and were effective for the year ended December 31, 2003. In September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1, which delays the recognition and measurement provisions of EITF 03-1 pending the issuance of further implementation guidance. EITF 03-1 and EITF 03-1-1 do not have an impact on our results of operations or financial condition. In June 2004, the FASB released EITF 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128" (EITF 03-6). This pronouncement provides guidance on when to apply the two-class method for computing basic and diluted earnings per share for participating securities. A participating security is a security that participates in undistributed earnings with common stock regardless of whether the participation is dependent upon the occurrence of a specific event. EITF 03-6 did not impact the Company's results of operations or financial condition. In December, 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) "Share-based Payment" (SFAS 123R) which eliminates the ability to account for share-based compensation transactions using Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," (APB 25) and generally requires that such transactions be accounted for using a fair value-based method with the resulting compensation cost recognized over the period that the employee is required to provide service in order to receive their compensation. SFAS 123R also amends SFAS No. 95, "Statement of Cash Flows," requiring the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required. The provisions of this statement are effective in the first fiscal beginning after June 15, 2005. The impact of the adoption of SFAS 123 is addressed above (see stock-based compensation) and the impact of adopting SFAS 123R is not expected to be materially different. Impact of Inflation ------------------- Inflation affects us most significantly in the area of loan originations and can have a substantial effect on interest rates. Interest rates normally increase during periods of high inflation and decrease during periods of low inflation. Profitability may be directly affected by the level and fluctuation in interest rates that affect our ability to earn a spread between interest received on its loans and the costs of its borrowings. Our profitability is likely to be adversely affected during any period of unexpected or rapid changes in interest rates. A substantial increase in interest rates could adversely affect our ability to originate loans and affect the mix of first and second-lien mortgage loan products. Generally, first-lien mortgage production increases relative to second-lien mortgage production in response to low interest rates and second-lien mortgage production increases relative to first-lien mortgage production during periods of high interest rates. 20 Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements. Tabular Disclosure of Contractual Obligations The following table presents our contractual obligations as of December 31, 2004:
Payment Due By Period ------------------------- ---------------------- ----------------------- ---------------------- ---------------------- Total Less than One Year 1 to 3 Years 3 to 5 Years ----- ------------------ ------------ ------------ ------------------------- ---------------------- ----------------------- ---------------------- ---------------------- Subordinated debt due formerly related party $1,531 $ 580 $951 $--- ------------------------- ---------------------- ----------------------- ---------------------- ---------------------- Convertible debentures $ 379 $ 379 $----- $--- ------------------------- ---------------------- ----------------------- ---------------------- ---------------------- Short-term debentures $ 221 $ 221 $----- $--- Promissory notes $ 48 $ 48 $----- $--- Notes due related $ 25 $ 25 $----- $--- Operating leases $ 78 $ 55 $ 23 $--- ---------------------- ----------------------- ---------------------- ---------------------- $2,282 $1,308 $974 $--- ====================== ======================= ====================== ======================
The fair value of our contractual obligations approximate the carrying value. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK General We carry interest-sensitive assets on our balance sheet that are financed by interest-sensitive liabilities. Since these interest-sensitive assets and liabilities are not necessarily correlated, we are subject to interest-rate risk. A sudden and sustained increase or decrease in interest rates would impact the fair value of any interest-sensitive assets on our balance sheet. We do not hedge against this interest-rate risk. The following table illustrates the timing of the re-pricing of our interest-sensitive assets and liabilities as of December 31, 2004 and 2003. We have made certain assumptions in determining the timing of re-pricing of such assets and liabilities.
Description Zero to Six Months ----------- ------------------ ------------------------ ------------------------ 2004 2003 ------------------------ ------------------------ Interest-sensitive assets: ------------------------ ------------------------ Cash and cash equivalents $ 135 $ 70 ------------------------ ------------------------ Total interest-sensitive assets $ 135 $ 70 ======================== ======================== Interest-sensitive liabilities: Promissory notes $ 221 $ 245 ------------------------ ------------------------ Total interest-sensitive liabilities $ 221 $ 245 ======================== ========================
21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The response to this item is incorporated by reference from our consolidated financial statements and notes thereto which are included in this report beginning on page F-1. Certain selected quarterly financial data is included under Item 7 of this Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The information called for pursuant to this Item 9 is incorporated by reference from our definitive proxy statement, which we intend to file with the Securities and Exchange Commission no later than April 29, 2005. ITEM 9A. CONTROLS AND PROCEDURES As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance that the information that we must disclose in our reports filed under the Securities and Exchange Act is communicated and processed in a timely manner. Paul K. Danner, Chairman and Chief Executive Officer, and Scott Vining, Chief Financial Officer and Treasurer, participated in this evaluation. Based on such evaluation, Mr. Danner and Mr. Vining concluded that, as of the date of such evaluation, our disclosure controls and procedures were effective. During the most recent fiscal quarter, there have not been any significant changes in our internal controls or in other factors that could significantly affect those controls. ITEM 9B. OTHER INFORMATION None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Identification of Directors. The Board of Directors presently consists of four members. Directors are elected annually at the annual meeting of stockholders. Their respective terms of office continue until the next annual meeting of stockholders and until their successors have been elected and qualified in accordance with our Bylaws. Certain information regarding each of our current directors, including his principal occupation during the past five years and current directorships, is set forth below. Name Age Position ---- --- -------- Paul K. Danner 47 Chairman and Chief Executive Officer George O. Deehan 62 Director Charles D. Van Sickle 63 Director Stephen J. Croskrey 44 Director 22 PAUL K. DANNER, has served as our Chairman and Chief Executive Officer from November 2005 and as a Director since June 2002. Mr. Danner is active in the United States Naval Reserve where he currently holds the rank of Captain and serves as the Commanding Officer of a Naval Air Systems Command unit headquartered at Naval Station Newport, RI. Mr. Danner was Chairman from September 2002 to December 2003 and Vice Chairman from June 2002 to September 2002. Mr. Danner also served as Secretary from June 2002 to May 2003 and Treasurer from June 2001 to December 2002. From August 2001 to May 2002, Mr. Danner was a director and Chief Executive Officer of Paragon Homefunding, Inc., the entity that merged with a subsidiary of the Company. Mr. Danner was a founder of that company. From January 1999 to October 2000 Mr. Danner was employed in various roles at MyTurn.com, Inc., including as Chief Executive Officer. MyTurn later filed for protection under the federal bankruptcy laws in March 2001. From 1997 to 1998, Mr. Danner served as Vice President of Zekko Corp., a technology company and from 1996 to 1997 Mr. Danner was the managing partner of Technology Ventures, a consulting firm. From 1985 to 1998 he held executive-level and sales & marketing positions with a number of technology companies including NEC Technologies and Control Data Corporation. Mr. Danner previously served on active duty with the United States Navy where he flew the F-14 Tomcat. GEORGE O. DEEHAN, has served as a Director since September 2003, our Chairman from January 2004 to November 2004 and as our Chief Executive Officer from October 2003 to November 2004. Mr. Deehan is a consultant to and an investor in eOriginal, Inc., a software development company, since March 2002. Mr. Deehan was President of eOriginal, Inc. from August 2000 until March 2002. Mr. Deehan was President and Chief Executive Officer of Advanta Leasing Services, the business equipment leasing unit of Advanta Business Services, from August 1998 until August 2000. Prior to joining, Advanta, Mr. Deehan served as President and Chief Operating Officer of Information Technology Services for AT&T Capital. Mr. Deehan is a director of NYFIX, Inc. and Sunset Financial Resources, Inc. which file reports under the Securities Exchange Act of 1934. CHARLES D. VAN SICKLE, has served as a director since February 2004. Mr. Van Sickle is a founder and director of KVI Capital, an equipment leasing and finance company based in Jacksonville, Florida since April 2000. From November 1998 to May 2000, Mr. Van Sickle was President and CEO of Healthcare Financial Services Corporation, a New York City based healthcare finance company. From May 1986 to January 1998, Mr. Van Sickle had various roles and responsibilities at AT&T Capital Corporation headquartered in Morristown, New Jersey. STEPHEN E. CROSKREY, has served as a director since March 2005. From February 1999 to March 2005, Mr. Croskrey served as the President & CEO of the Products Division of Armor Holdings, Inc. Prior to Armor Holdings, Mr. Croskrey held senior executive positions with Allied Signal and Mobil Oil. Mr. Croskrey is a graduate of the Kellogg School of Management at Northwestern University where he completed the MBA program in 1998, and the United States Military Academy at West Point where in 1982 he earned a BS degree in Engineering and was commissioned as an officer in the United States Army. Mr. Croskrey spent 6 years on active duty during which time he attained the rank of Captain and served as a Company Commander in Korea and Fort Lewis, Washington. (b) Identification of Executive Officers. Officers are elected annually by our Board of Directors and serve at the discretion of the Board of Directors. Our executive officers as of April 29, 2005 are set forth below. PAUL K. DANNER, see "Identification of Directors" in Item 10(a) of this Annual Report on Form 10-K/A for Mr. Danner's biographical information. SCOTT L. VINING, 42, has served as our Chief Financial Officer and Treasurer since March 2003. From September 1996 to March 2003, Mr. Vining was employed by Armor Holdings, Inc. most recently as Treasurer and Chief Accounting Officer. Mr. Vining is a certified public accountant. 23 (c) Identification of Certain Significant Employees. Not applicable. (d) Family Relationships. There are no family relationships between any director, executive officer, or person nominated or chosen by us to become a director or executive officer. (e) Business Experience. The business experience of each of our directors and executive officers is set forth in Item 10(a)--Identification of Directors of this Annual Report on Form 10-K/A and the business experience of those executive officers who are not also our directors is set forth in Item 10(b)--Identification of Executive Officers of this Annual Report on Form 10-K/A. The directorships held by each of our directors in any company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended, or subject to Section 15(d) of such Act or any company registered as an investment company under the Investment Company Act of 1940, as amended, are set forth in Item 10(a)--Identification of Directors of this Annual Report on Form 10-K/A. (f) Involvement in Certain Legal Proceedings. Except as set forth in Item 10(a)--Identification of Directors of this Annual Report on Form 10-K/A related to Mr. Danner, to the best of our knowledge, none of our other directors or executive officers has been involved during the past five years in any legal proceedings required to be disclosed pursuant to Item 401(f) of Regulation S-K. (g) Promoters and Control Persons. Not applicable. (h) and (i) Audit Committee and Audit Committee Financial Expert. The full Board of Directors currently performs the functions of an Audit Committee. Two members of the Board of Directors, Charles D. Van Sickle and Stephen Croskrey satisfy the definition of "independent" as defined under the NASDAQ listing standards. The Board has not adopted a written charter for the audit committee at this time. (j) Procedures for Stockholder Nominations to our Board of Directors. No material changes to the procedures for nominating directors by our stockholders were made in 2004. Code of Conduct and Ethics We have adopted a Code of Business Conduct and Ethics that applies to all Paragon employees, including our chief executive and financial officers. This document has been filed as Exhibit 14.1 to this Annual Report on Form 10-K for the year ended December 31, 2004. Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the Exchange Act requires our directors and executive officers, and persons who own more than ten percent of a registered class of our equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Directors, executive officers, and greater than ten percent holders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. The Company believes that during the 2004 fiscal year, the officers, directors and holders of more than 10% of the Company's Common Stock complied with all Section 16(a) filing requirements, with the following exceptions: Mr. Deehan received options to purchase 3,000,000 shares of our common stock on July 29, 2004 at $0.04 per share (the market price on that date). This transaction has not been reported on Form 4. 24 Mr. Vining received options to purchase 3,000,000 shares of our common stock on July 29, 2004 at $0.04 per share (the market price on that date). This transaction was subsequently reported on Form 4 filed by Mr. Vining on May 2, 2005. Mr. Christopher Liston sold 4,970,000 shares of our common stock in 2004. The transactions associated with these sales have not been reported on Form 4. Mr. Van Sickle received 625,000 shares of our common stock (valued at $25,000) on December 31, 2004 in payment for services as a director. This transaction has not been reported on Form 4. ITEM 11. EXECUTIVE COMPENSATION The following table provides certain summary information concerning compensation (including salary, bonuses, stock options, and certain other compensation) paid by us for services in all capacities or accrued for the fiscal years ended December 31, 2004, 2003 and 2002 to our Chief Executive Officer during the most recently completed fiscal year-end and to the other person who served as our executive officer at December 31, 2004 and whose salary plus bonus exceeded $100,000 in Fiscal Year 2004 (together being hereinafter referred to as the "Named Executive Officers").
Annual Compensation Long-term Compensation ------------------- ---------------------- Fiscal Salary Bonus Other Annual Securities All Other Year ($) $ Comp Underlying Compensation Name and Principal Position ---- ------ ----- $ Options(#) ------------ --------------------------- ------------ ---------- 2004 $ -- $ -- $ -- -- -- Paul K. Danner Current Chairman of the Board and CEO 2004 $ 100,000 -- -- 3,000,000 70,000 George O. Deehan 2003 $ 51,846 -- -- 12,500,000 -- Former Chairman of the Board and Former CEO 2003 $ 150,000 -- -- -- -- Steven A. Burleson 2002 $ 66,667(1) $ 30,000 $14,281(2) 16,000,000 -- Former CEO, Former Interim Chief Financial Officer and Former Director 2004 $ 45,000 -- -- 3,000,000 -- Scott L. Vining 2003 $ 100,000 -- -- -- -- Chief Financial Officer and Treasurer
(1) Represents salary earned during 2002 for Mr. Burleson pursuant to Mr. Burleson's employment agreement dated September 5, 2002. Mr. Burleson received no cash compensation in 2002 and amounts due for 2002 were converted into Series E Preferred Stock in March 2003. The Company began paying Mr. Burleson's salary pursuant to his employee agreement in February 2003. (2) Represents auto allowance of $10,500 and the value of health and other personal benefits in the amount of $3,781. 25 Stock Option Grants in 2004 We granted the following options to our Named Executive Officers during fiscal 2004.
Individual Grants Name Number of Percent of Exercise Potential Realizable Value Securities Total Options Price Expiration At Assumed Annual Underlying Granted to Per Date Rate Option Employees in Share --------- of Stock Price Appreciation Grants (#) Fiscal Year ----- for Option Term ---------- ----------- --------------- 5% 10% Paul K. Danner -- -- -- -- -- -- George O. Deehan 3,000,000 13.1 $ 0.04 7/29/2014 $ 75,467 $ 191,249 Scott L. Vining 3,000,000 13.1 $ 0.04 7/29/2014 $ 75,467 $ 191,249 Stock Option Exercises and Option Values for 2004
None of the Executive Officers named in the Summary Compensation Table exercised any stock options in 2004. The table below sets forth information concerning the number and value of their unexercised stock options at December 31, 2004.
Number of Securities Value of Underlying Underlying Unexercised In-The-Money Options Options at 12/31/04 (#) at 12/31/04 (1) (2) Non- Non- Name Exercisable Exercisable Exercisable Exercisable ---- ----------- ----------- ----------- ----------- Paul K. Danner George O. Deehan 2,000,000 3,000,000 $ -- $ -- Scott L. Vining 666,667 3,333,333 $ -- $ --
(1) Calculated on the basis of $0.04 per share, the closing sales price of the common stock on the OTC Bulletin Board December 31, 2004, less the exercise price payable for such shares. (2) The exercise prices of shares underlying unexercised options were at or above the market value of the common 26 Equity Compensation Plan Information The following table summarizes our equity compensation plan information as of December 31, 2004. Equity Compensation Plan Information(1)
Number of Number of securities securities to be remaining available for issued upon future issuance under exercise of equity compensation plans outstanding option Weighted-average (excluding issued and and warrants exercise price of outstanding (outstanding options, Plan category --------------- options, warrants and rights warrants and rights) ------------- ---------------------------- -------------------- Equity compensation plans approved by security holders: 54,245,342 $ 0.15 45,754,658 Equity compensation plans approved by security holders: -- -- -- ---------- ---------------------- ---------- TOTAL 54,245,342 $ 0.15 45,754,658
Employment Contracts and Termination, Severance and Change of Control Arrangements Messrs. Danner, Deehan and Vining were employed by the Company pursuant to written employment agreements. On May 31, 2004, we released Messrs. Deehan and Vining from these agreements by the Company. Our current named executive officers are not covered by written employment agreements. Compensation of Directors Mr. Van Sickle received 625,000 shares of our common stock (valued at $25,000 on December 31, 2004) for his services as a director for the year ended December 31, 2004. All members of the Board of Directors receive reimbursement for expenses associated with attendance of meeting of the Board of Directors. Report on Executive Compensation The Company's executive compensation program is designed to attract, motivate and retain management with incentives linked to financial performance and enhanced stockholder value. Our compensation program currently consists of a number of components, including a cash salary, cash incentive bonuses, and stock option grants. We currently do not have a compensation committee. The Board of Directors as a whole, reviews salary, bonus and option award information for competitive companies of comparable size in similar industries, as well as that of companies not in its industry which do business in locations where the company has operations. Based in part on this information, the Board of Directors generally sets salaries at levels comparable to such companies. Bonuses are generally discretionary, but in some cases may be set forth in employment agreements and based on the achievements of performance thresholds. In either case, bonuses are linked to company performance during the year and thus align the interest of executive officers with those of the stockholders. The Board of Directors also assesses each executive officer's individual performance and contribution in determining bonus levels. The Board of Directors uses grants out of our 2002 Equity Participation Plan to motivate its executive officers and to improve long-term market performance of the Company's common stock. 27 Since the Board of Directors believes that the granting of options to purchase shares of common stock provides its executive employees with the long-term incentive to work for the betterment of the Company, stock options are granted to executives, in some cases upon commencement of employment and in some cases periodically. Additionally, grants of options are made periodically to other selected employees which contributions and skills are critical to the long-term success of the Company. Options are generally granted with the exercise price equal to the market price of our shares of common stock on the date of grant, generally vest over a period of at least three years and generally expire after ten years. Compensation Committee Interlocks and Insider Participation During the year ended December 31, 2004 each of Messrs. Deehan and Danner were directors and employees of the Company. Mr. Deehan received compensation as an employee in accordance with his agreement with the Company. See "Executive Officers--Employment Agreements" and "Related Party Transactions." Each director participated in discussions regarding executive compensation. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth certain information with respect to beneficial ownership of our shares of common stock as of April 29, 2005: (i) by each person (or group of affiliated persons) who we know to own beneficially more than five percent of our outstanding shares of common stock; (ii) by the individuals who served as our chief executive officer during the fiscal year ended December 31,2004; (iii) by the executive officer other than the chief executive officer who was employed by us on December 31, 2004; (iv) by each of our directors; and (v) by all of our current directors and executive officers as a group. As of April 29, 2005, we had 86,706,250 shares of common stock outstanding. Except as indicated in the footnotes to this table, the persons named in the table have sole voting and investment power with respect to all shares shown as beneficially owned by them.
Beneficially Percent Owned of Shares Class Name and Address of Beneficial Owner* Number(1) -------- ------------------------------------- --------- 5% Stockholder Christopher Liston 9,458,684 9.3% 918 Ponte Vedra Blvd. Ponte Vedra, FL 32082 Abhijit Deshmukh (2) 6,493,506 6.4% 830-13 A1A North, #414 Ponte Vedra Beach, FL 32082 Steven A. Burleson (3) 7,000,000 6.9% 1828 Lake Marshall Dr. Gibsonia, PA 15044 Named Executive Officers and Directors Stephen Croskrey (4) 22,103,896 21.8% Paul K. Danner (5) 19,699,928 19.4% George O. Deehan (6) 2,336,000 2.3% Charles Van Sickle (7) 745,000 *% Scott L. Vining (8) 666,667 *% All current directors and executive officers as a group (5 persons) (9) 45,551,491 44.9%
* - Less than 1% 28 (1) As used in this table, a beneficial owner of a security includes any person who, directly or indirectly, through contract, arrangement, understanding, relationship or otherwise has or shares (a) the power to vote, or direct the voting of, such security or (b) investment power which includes the power to dispose, or to direct the disposition of, such security. In addition, a person is deemed to be the beneficial owner of a security if that person has the right to acquire beneficial ownership of such security within 60 days. (2) Includes warrants to purchase 3,246,753 shares of common stock. (3) Includes options to purchase 7,000,000 shares of common stock. (4) Includes warrants to purchase 11,551,948 shares of common stock. The address for Mr. Croskrey is 830-13 A1A (5) Includes 825,000 shares held in a custodial accounts for the benefit of Mr. Danner's minor children of which (6) Includes options to purchase 2,000,000 shares of common stock, warrants to purchase 56,000 shares of common (7) Includes warrants to purchase 20,000 shares of common stock and the conversion into 100,000 shares of common (8) Includes options to purchase 666,667 shares of common stock. The address for Mr. Vining is 830-13 A1A North, (9) See footnote (4 - 8). ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On June 4, 2004, subject to certain conditions, confidentiality provisions and approval of the majority of the holders of our common stock, we agreed to sell our largest subsidiary, PGNF Home Lending Corp. ("PGNF"), to Philip Lagori ("Lagori"), the former owner of PGNF, and formerly, our largest shareholder (the "PGNF Transaction") holding 52,329,734 shares of our common stock (or 50.5%). On June 30, 2004, we received consent from holders of 97,647,656 shares (or 83.89%) of our common stock on a pre-PGNF Transaction basis and completed this sale. After affecting the number of outstanding shares resulting from the PGNF Transaction, we received consent from holders of 45,317,921 shares (or 70.74%) of our common stock. Pursuant to the agreement, we exchanged the common stock of PGNF, as well as the assumption of all of PGNF's liabilities, contingent and otherwise, for 52,329,735 shares of our common stock valued at $2,355,000 (based upon the closing price of $0.045 on June 30, 2004) and 1,800 shares of our Series E preferred stock plus accrued dividend valued at $1,904,000. 29 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES During the years ended December 31, 2004 and 2003, fees for services provided by Stevens, Powell & Company, P.A. ("Stevens, Powell & Company"), our independent registered public accounting firm, were as follows:
Year Ended December 2004 2003 ---- ---- Audit Fees (1) $ 68,623 $ 74,000 Tax Fees (2) 11,215 -- Total $ 79,838 $ 74,000
(1) Audit Fees consisted of fees billed for services rendered and expenses incurred for the audit of the Company's annual financial statements, review of financial statements included in the Company's quarterly reports on Form 10-Q, and other services normally provided in connection with statutory and regulatory filings. (2) Tax Fees consisted of fees billed for preparation of required income tax returns. Our Board of Directors has determined that the rendering of non-audit services by Stevens, Powell & Company was compatible with maintaining their independence. Audit Committee Pre-Approval Policy Our Board of Directors requires the pre-approval of any audit or non-audit engagement of Stevens, Powell & Company. In the event that we wish to engage Stevens, Powell & Company to perform accounting, technical, diligence or other permitted services not related to the services performed by Steven, Powell & Company as our independent registered public accounting firm, management of the company summarizes for the Board of Directors the proposed engagement, the nature of the engagement and the estimated cost of the engagement. This information is reviewed by our Board of Directors, who evaluates whether the proposed engagement will interfere with the independence of Stevens, Powell & Company in the performance of its auditing services. For 2004, all audit and non-audit services were approved by the Board of Directors prior to the commencement of such work by Steven, Powell & Company. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K (a) The following financial statements (which appear sequentially beginning at page number F-1) are included in this report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included. Reports of Independent Certified Public Accountants Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Comprehensive Loss Consolidated Statements of Stockholders' Deficiency Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 30 (b) Reports on Form 8-K None. (c) Exhibits The following Exhibits are hereby filed as part of this Annual Report on Form 10-K:
Exhibit Number Description of Exhibit ------ ---------------------- 2.1 Agreement and Plan of Merger dated as of October 14, 2002 among PlanetRx.com, Inc. (n/k/a Paragon Financial Corporation), Paragon Homefunding, Inc. a Delaware Corporation and Mortgage Express, Inc. (n/k/a PGNF Home Lending Corp., et al (the "Mortgage Express Plan of Merger").** 2.2 Amendment No. 1 to the Mortgage Express Plan of Merger.*** 2.3 Agreement and Plan of Merger dated December 9, 2002 among PlanetRx.com, Inc. (n/k/a Paragon Financial Corporation), Paragon Acquisition Corp. II, Paragon Homefunding, Inc., a Florida corporation, et al.(the "Paragon Homefunding Plan of Merger").*** 2.4 Amendment No. 1 to the Paragon Homefunding Florida Plan of Merger.*** 2.5 Stock Purchase Agreement between Paragon and Philip Lagori for the sale of PGNF Homelending Corp. + 3.1 Restated Certificate of Incorporation filed with the Secretary of State of the State of Delaware on October 6, 1999. **** 3.2 Certificate of Amendment of the Restated Certificate of Incorporation filed with the Secretary of State of the State of Delaware on October 13, 2000. **** 3.3 Certificate of Amendment to Restated Certificate of Incorporation filed with the Secretary of State of the State of Delaware on November 30, 2002. **** 3.4 Certificate of Amendment of the Restated Certificate of Incorporation filed with the Secretary of State of the State of Delaware on December 26, 2002. **** 3.5 Certificate of Designations of Series E Preferred Stock.***** 3.6 Amended and Restated By-laws. **** 4.1 Form of convertible promissory note. **** 4.2 5% Subordinated promissory note due November 30, 2005 for $480,000 + 4.3 5% Subordinated promissory note due May 31, 2008 for $1,051,225 + 10.1 Amended and Restated Employment Agreement, dated as of September 1, 2002 by and between PlanetRx.com, Inc. (now known as Paragon Financial Corporation) and Paul Danner. **** 10.2 Employment Agreement, dated as of September 4, 2002 by and between PlanetRx.com, Inc. (now known as Paragon Financial Corporation) and Steven A. Burleson. ****
31
10.3 Employment Agreement, dated as of January 31, 2003 by and between Paragon Financial Corporation and Philip Lagori. **** 10.4 Employment Agreement, dated as of December 30, 2002 by and between Paragon Financial Corporation and Scott Vining. **** 10.5 Lease dated January 1, 2003 between Ponte Vedra Management Group, Ltd. and Paragon Financial Corporation. **** 10.6 Lease dated September 1, 2000 between 820 West Lake, LLC and Mortgage Express, Inc. (n/k/a PGNF Home Lending Corp.). **** 10.7 Employment Agreement, dated October 16, 2003, by and between Paragon Financial Corporation and George O. Deehan ***** 10.8 Employment Agreement, dated June 17, 2003, by and between Paragon Financial Corporation and Joseph P. Bryant, Jr. ***** 10.9 Employment Agreement, dated May 6, 2003, by and between Paragon Financial Corporation and Steven L. Barnett. ***** 21.1 Subsidiary of the Registrant* 23.1 Consent of Accountant* 31.1 Certification of Chief Executive Officer pursuant to Form of Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated April 12, 2005 * 31.2 Certification of Chief Financial Officer pursuant to Form of Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated April 12, 2005 * 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated April 12, 2005 *
------------------------- * Filed herewith + Filed as an exhibit to Paragon's Current Report on Form 8-K/A, as amended, for an event dated June 30, 2004 @ This exhibit represents a management contract ** This exhibit represents a compensatory plan *** Filed as an exhibit to Paragon's Current Report on Form 8-K for an event dated January 31, 2003 **** Filed as an exhibit to Paragon's Annual Report on Form 10-K for the year ended December 31, 2002 *****Filed as an exhibit to Paragon's Quarterly Report for the period ended September 30, 2003, as amended 32 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firms F-1 & 2 Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Comprehensive Loss F-5 Consolidated Statements of Cash Flows F-6 Consolidated Statements of Stockholders' Deficiency F-7 & 8 Notes to Consolidated Financial Statements F-9 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS PARAGON FINANCIAL CORPORATION We have audited the accompanying consolidated balance sheets of Paragon Financial Corporation and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive loss, cash flows, and stockholders' deficiency for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive loss, cash flows, and stockholders' deficiency for the years then ended, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 3 to the consolidated financial statements, the Company has suffered losses from operations and has a negative tangible net worth that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Note 17, the accompanying consolidated balance sheet as of December 31, 2004, and the consolidated statements of operations, comprehensive loss, cash flows, and stockholders' deficiency for the year ended December 31, 2004, have been restated. /s/ STEVENS, POWELL & COMPANY, P.A. Jacksonville, Florida March 23, 2005, except as to Note 16 for which the date is April 7, 2005, and October 1, 2008, as to the effects of the restatement discussed in Note 17 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS PARAGON FINANCIAL CORPORATION We have audited the accompanying statements of operations, stockholders' deficiency and cash flows of Paragon Financial Corporation (a development stage company) for the year ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Paragon Financial Corporation for the year ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. The financial statements referred to above have been prepared assuming that the Company will continue as a going concern. As described in Note 3 to the financial statements, the Company has suffered losses from operations and has net working capital and stockholders' deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The financial statements referred to above do not include any adjustments that might result from the outcome of this uncertainty. /s/ BP PROFESSIONAL GROUP LLP Farmingdale, New York March 6, 2003 F-2
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2004 AND DECEMBER 31, 2003 (Dollars in thousands, except share data) 2004 2003 -------------- --------------- (As Restated, Note 17) Assets Current Assets: Cash $ 135 $ 70 Fees receivable 46 80 Prepaid and other current assets 9 37 -------------- --------------- Total Current Assets 190 187 -------------- --------------- Office property and equipment, net of accumulated depreciation of $43 and $27 64 132 Goodwill - 822 Other assets 3 475 Assets of discontinued operations - 34,046 -------------- --------------- Total Assets $ 257 $ 35,662 ============== =============== Liabilities and Stockholders' Deficiency Current liabilities Current portion of long-term debt $ 100 $ - Short-term debt 221 245 Notes payable - related parties 528 20 Notes payable - related parties 25 25 Convertible debentures payable 379 379 Accounts payable 371 290 Stock subscription proceeds received 178 - Accrued expenses - related parties 59 59 Income taxes payable 10 - Accrued expenses - other 383 514 -------------- --------------- Total Current Liabilities 2,254 1,532 Long-term debt: Liabilities to formerly related parties, less current portion 951 - Liabilities of discontinued operations - 26,154 -------------- --------------- Total Liabilities 3,205 27,686 -------------- --------------- Stockholders' deficiency Preferred stock: Issuable in series, $0.0001 par value; 5,000,000 shares authorized: Series E, $1,000 stated value; 659 and 2,459 shares issued and outstanding, respectively - - Common stock, $0.0001 par value; 400,000,000 shares authorized, 65,212,744 and 116,396,479 shares issued and outstanding at December 31, 2004 and December 31, 2003, respectively 6 11 Additional paid-in capital 6,914 11,779 Accumulated deficit (9,861) (3,964) Cumulative comprehensive income - 202 Unearned stock-based compensation (7) (52) -------------- --------------- Total Stockholders' (deficit) equity (2,948) 7,976 -------------- --------------- Total liabilities and stockholders' deficiency $ 257 $ 35,662 ============== =============== See accompanying notes to consolidated financial statements. F-3
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (Dollars in thousands, except share data) 2004 2003 2002 ---------------- ---------------- --------------- (As Restated, Note 17) Revenue: Loan orgination fees $ 2,034 $ 1,964 $ - ---------------- ---------------- --------------- Expenses: Salaries, commissions, benefits, and stock-based compensation 1,916 2,517 1,768 Loan production costs 91 103 - General ad administrative expenses 858 1,113 569 Impairment of goodwill 822 - - Non-recurring charges 25 333 - ---------------- ---------------- --------------- Total expenses 3,712 4,066 2,337 ---------------- ---------------- --------------- Operating loss (1,678) (2,102) (2,337) Interest expense, net 107 415 5 Loss on disposal of assets 15 - - Loss on disposal of segment 102 - - ---------------- ---------------- --------------- Loss from continuing operations before provision for income taxes (1,902) (2,517) (2,342) Provisions (benefit) for income taxes 456 (837) - ---------------- ---------------- --------------- Loss from continuing operations (2,358) (1,680) (2,342) Discontinued operations (Note 2): (Loss) income from discontinued operations before provision (benefit) for taxes (3,539) 565 - (Benefit) provision for income taxes - 282 - ---------------- ---------------- --------------- (Loss) income from discontinued operations (3,539) 283 - ---------------- ---------------- --------------- Net Loss $ (5,897) $ (1,397) $(2,342) ================ ================ =============== Per share information Net Income Per Share - Basic and Diluted: Loss from continuing operations $ (0.03) $ (0.01) $ (0.04) (Loss) income from discontinued operations (0.04) - - ---------------- ---------------- --------------- $ (0.07) $ (0.01) $ (0.04) ================ ================ =============== Weighted average shares outstanding - basic and diluted 85,799 111,620 54,407 ---------------- ---------------- --------------- See accompanying notes to consolidated financial statements.
F-4
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS FOR THE YEARS ENDED DECEMBER 31, 2004, AND 2003 (Dollars in thousands, except share data) 2004 2003 ----------------- ----------------- (As Restated, Note 17) Net Loss $ (5,897) $ (1,397) ----------------- ----------------- Other comprehensive income: Unrealized gain on available-for-sale securities, net of income taxes - 202 ----------------- ----------------- Comprehensive loss $ (5,897) $ (1,195) ================= ================= See accompanying notes to consolidated financial statements.
F-5
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (Dollars in thousands) 2004 2003 2002 -------------- -------------- -------------- (Restated, Note 17) Net loss from continuing operations $ (2,358) $ (1,680) $ (2,342) Adjustments to reconcile net loss to cash provided by operating activities of continuing operations: Depreciation 30 26 1 Impairment of goodwill 822 - - Loss on sale of assets 15 - - Loss on disposal of segment 102 - - Deferred compensation to related parties, subsequently converted to preferred shares - - 504 Non-cash stock compensation 87 86 1,256 Deferred taxes 444 (446) - Changes in assets and liabilities: (Increase) decrease in fees receivable 34 (31) - Decrease (increase) in prepaid and other current assets 57 105 (31) Increase in accounts payable 91 113 67 (Decrease) increase in accrued expenses (93) 617 225 Increase in income taxes payable 10 - - -------------- -------------- -------------- Cash used in operating activities from continuing operations (759) (1,210) (320) -------------- -------------- -------------- CASH FLOWS USED IN INVESTING ACTIVITIES OF CONTINUING OPERATIONS: Purchase of property and equipment (2) (117) (2) Cash acquired in purchase of business - 44 - Proceeds from the sale of assets 25 - - Proceeds from the sale of websites 30 52 - Deposits made - - (25) Deferred merger costs - - (58) -------------- -------------- -------------- Cash provided by (used in) investing activities from continuing operations 53 (21) (85) -------------- -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES OF CONTINUING OPERATIONS: Proceeds from issuance of common stock - - 386 Proceeds from the issuance of warrants - 18 6 Proceeds from common stock subscriptions 178 - - Proceeds from issuance of debentures - 222 104 Borrowings under line of credit - 245 - Repayments of debt (45) (35) - -------------- -------------- -------------- Cash provided by financing activities from continuing operations 133 450 496 -------------- -------------- -------------- Net cash provided by discontinued operations 638 760 - Increase (decrease) in cash and cash equivalents 65 (21) 91 Cash and Cash Equivalents - Beginning of Period 70 91 - -------------- -------------- -------------- Cash and Cash Equivalents - End of Period $ 135 $ 70 $ 91 ============== ============== ============== See accompanying notes to consolidated financial statements.
F-6
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY FOR THE YEARS ENDED DECEMBER 31, 2004 (As Restated, Note 17), 2003 AND 2002 (Dollars in thousands) Additional Preferred Common Stock paid-in Subscriptions Treasury Accumulated Shares Amount Number of shares Amount Capital Receivable Stock Deficit ---------------------------------------------------------------------------------------------------- Balance - January 1, 2002 - $ - 33,822,480 $ 3 $ 26 $ (1) $ - $ (225) March 1 Contribution from financing shareholders of 5,477,325 shares as treasury stock - - - - 200 1 (200) - March 1 Issuance of 16,431,975 restricted and unrestricted shares for services - - 10,954,650 1 399 - 200 - May 31 Issuance of shares for cash - - 10,783,486 1 384 - - - May 31 Issuance of shares to effect reverse acquisition - - 6,173,403 1 (73) - - - June 30 Amortization of restricted shares - - - - - - - - July10 Issuance of shares for services - - 458,725 - 46 - - - July 16 Rescision of 16,431,975 shares and re-issuance and reallocation as unrestricted shares - - - - 148 - - - August 1 Contribution of services by shareholder - - - - 5 - - - November 8 Issuance of shares for services - - 400,000 - 36 - - - December 30 Issuance of options to consultants - - - - 421 - - - December 31 Issuance of warrants included in convertible debentures - - - - 6 - - - December 31 Beneficial conversion feature on convertible debentures - - - - 95 - - - Net loss - - - - - - - (2,342) ---------------------------------------------------------------------------------------------- Balance - December 31, 2002 - - 62,592,744 6 1,693 - - (2,567) January 31 Issuance of shares for acquisition - - 52,329,735 5 6,362 - - - February 4 Issuance of shares for acquisition - - 1,224,000 - 836 - - - March 26 Issuance of preferred stock for accrued compensation 659 - - - 659 - - - March 26 Issuance of preferred stock for promissory note and accrued interest 1,800 - - - 1,812 - - - March 31 Issuance of warrants included in convertible debentures - - - - 18 - - - March 31 Beneficial conversion feature on convertible debentures - - - - 222 - - - March 31 Receipt of cash for websites - - - - 13 - - - May 12 Issuance of restricted stock award - - 250,000 - 125 - - - May 30 Receipt of cash for websites - - - - 35 - - - June 30 Amortization of restricted stock award - - - - - - - - September 12 Receipt of cash for websites - - - - 1 - - - September 30 Amortization of restricted stock award - - - - - - - - November 14 Receipt of cash for website - - - - 3 - - - December 31 Amortization of restricted stock award - - - - - - - - Comprehensive loss: Net loss - - - - - - - (1,397) Unrealized gain on marketable securities - - - - - - - - Total comprehensive loss - - - - - - - - ----------------------------------------------------------------------------------------------- Balance - December 31, 2003 2,459 - 116,396,479 11 11,779 - - (3,964) March 31 Amortization of restricted stock award - - - - - - - - May 27 Receipt of cash for website - - - - 30 - - - June 30 Amortization of restricted stock award - - - - - - - - May 31 Disposal of segment (1,800) - (52,329,735) (5) (4,948) - - - July 1 Issuance of restricted stock award to consultant - - 200,000 - 10 - - - September 30 Amortization of restricted stock award - - - - - - - - October 13 Issuance of shares for insurance premium - - 125,000 - 6 - - - November 18 Issuance of shares for services - - 96,000 - 5 - - - November 18 Issuance of restricted shares for services - - 100,000 - 7 - - - December 31 Issuance of shares for directors fees - - 625,000 - 25 - - - December 31 Amortization of stock award - - - - - - - - Realization of comprehensive income - - - - - - - - Net loss - - - - - - - (5,897) ------------------------------------------------------------------------------------------------ Balance - December 31, 2004 659 $ - 65,212,744 $ 6 $ 6,914 $ - $ - $ (9,861) ================================================================================================ See accompanying notes to consolidated financial statements.
F-7 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY FOR THE YEARS ENDED DECEMBER 31, 2004 (As Restated, Note 17), 2003 AND 2002 (Dollars in thousands) (Continued) Accumulated Other Unearned Total Comprehensive Stock-based Stockholders' Income Compensation Deficiency -------------------------------------- Balance - January 1, 2002 $ - $ - $ (197) March 1 Contribution from financing shareholders of 5,477,325 shares as treasury stock - - 1 March 1 Issuance of 16,431,975 restricted and unrestricted shares for services - (400) 200 May 31 Issuance of shares for cash - - 385 May 31 Issuance of shares to effect reverse acquisition - - (72) June 30 Amortization of restricted shares - 62 62 July10 Issuance of shares for services - - 46 July 16 Rescision of 16,431,975 shares and re-issuance and reallocation as unrestricted share - 338 486 August 1 Contribution of services by shareholder - - 5 November 8 Issuance of shares for services - - 36 December 30 Issuance of options to consultants - - 421 December 31 Issuance of warrants included in convertible debentures - - 6 December 31 Beneficial conversion feature on convertible debentures - - 95 Net loss - - (2,342) --------------------------------------- Balance - December 31, 2002 - - (868) January 31 Issuance of shares for acquisition - - 6,367 February 4 Issuance of shares for acquisition - - 836 March 26 Issuance of preferred stock for accrued compensation - - 659 March 26 Issuance of preferred stock for promissory note and accrued interest - - 1,812 March 31 Issuance of warrants included in convertible debentures - - 18 March 31 Beneficial conversion feature on convertible debentures - - 222 March 31 Receipt of cash for websites - - 13 May 12 Issuance of restricted stock award - (125) - May 30 Receipt of cash for websites - - 35 June 30 Amortization of restricted stock award - 10 10 September 12 Receipt of cash for websites - - 1 September 30 Amortization of restricted stock award - 31 31 November 14 Receipt of cash for website - - 3 December 31 Amortization of restricted stock award - 32 32 Comprehensive loss: Net loss - - - Unrealized gain on marketable securities 202 - - Total comprehensive loss - - (1,195) --------------------------------------- Balance - December 31, 2003 202 (52) 7,976 March 31 Amortization of restricted stock award - 31 31 May 27 Receipt of cash for website - - 30 June 30 Amortization of restricted stock award - 21 21 May 31 Disposal of segment - - (4,953) July 1 Issuance of restricted stock award to consultant - (10) - September 30 Amortization of restricted stock award - 5 5 October 13 Issuance of shares for insurance premium - - 6 November 18 Issuance of shares for services - - 5 November 18 Issuance of restricted shares for services - (7) - December 31 Issuance of shares for directors fees - - 25 December 31 Amortization of stock award - 5 5 Realization of comprehensive income (202) - (202) Net loss - - (5,897) --------------------------------------- Balance - December 31, 2004 $ - $ (7) $ (2,948) ======================================= See accompanying notes to consolidated financial statements. F-8 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES THE COMPANY - Paragon Financial Corporation (the "Company") was incorporated in Delaware on August 27, 1999 under the name PRx Holdings, Inc. and operated as an online healthcare destination for commerce, content and community. The Company closed its online health store in March 2001. Shortly thereafter, the Company began the process of liquidating its online health store and seeking a merger partner as an alternative to complete liquidation. Paragon Homefunding, Inc. ("Paragon Delaware"), a privately held, development-stage company based in Ponte Vedra Beach, Florida, was incorporated in Delaware on August 3, 2001, for the purpose of entering the financial services market through acquisitions. On May 31, 2002, the Company merged with Paragon Delaware. Pursuant to the merger, the Company merged with and into Paragon Delaware, and issued 55,560,616 shares of common stock to the Paragon Delaware's stockholders constituting 90% of the total shares of the Company's common stock outstanding immediately after the merger. As a result of the merger, Paragon Delaware also assumed approximately $72 of the Company's accrued liabilities, principally for legal services. For financial reporting purposes, the merger has been accounted for as a recapitalization of Paragon Delaware with Paragon Delaware viewed as the accounting acquiror in what is commonly called a reverse acquisition. Accordingly, the financial statements presented before the merger are those of Paragon Delaware. ACQUISITIONS - On January 31, 2003, the Company completed its merger with PGNF Home Lending Corp. ("PGNF") (f/k/a Mortgage Express, Inc.), and as a result of the merger, PGNF became a wholly-owned subsidiary. PGNF has been in the business of originating residential mortgage loans since 1998. Subject to the terms of the merger agreement, at closing, all of the outstanding shares of PGNF's common stock converted into 52,329,735 shares of the Company's common stock valued at $6.4 million (or approximately $0.122 per share), or approximately 45.5% of the then outstanding common stock after the consummation of the merger. Additionally, the Company issued a promissory note in the amount of $1.8 million to an entity wholly-owned by the sole shareholder of PGNF. The promissory note accrued interest at 4.92% and was payable on July 31, 2004. On March 26, 2003, the holder of this note agreed to convert the note and accrued interest into 1,800 shares of our Series E preferred stock with a face value of $1,000 per share, and a 4% stated dividend payable in cash or shares of common stock, at the Company's option. This series of preferred stock does not provide for redemption and is non-voting. On May 31, 2004, the Company divested PGNF (See Note 2 - Discontinued Operations). On February 2, 2003 the Company completed its merger with Paragon Homefunding, Inc. ("PHF"). PHF has been in the business of originating residential mortgage loans since 1998. Subject to the terms of the merger agreement, at closing, all of the outstanding shares of PHF's common stock converted into 1,224,000 of shares of the Company's common stock valued at F-9 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) $836 (approximately $0.6833 per share). Additionally, the Company issued promissory notes to the shareholders of PHF in the aggregate principal amount of $25. The promissory notes accrue interest at 4.92% per annum. These mergers were accounted for as acquisitions pursuant to SFAS No. 141, Accounting for Business Combinations ("SFAS 141"). Accordingly, the Company's results of operations include the operating results of these companies from the effective date of these mergers, February 1, 2003. GENERAL - This summary of significant accounting policies is presented to assist in understanding the financial statements of the Company. The financial statements and notes are representations of the Company's management. The Company's management is responsible for the integrity and objectivity of these financial statements. PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. In consolidation, all material intercompany balances and transactions have been eliminated. Results of operations of companies acquired in transactions accounted for under the purchase method of accounting are included in the financial statements from the date of the acquisition. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. USE OF ESTIMATES - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that materially affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan repurchases and premium recapture, goodwill, and loss on disposal of our discontinued segment. Actual results could differ from those estimates. F-10 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) The determination of the adequacy of the allowance for loan repurchases and premium recapture losses is based on estimates that may be affected by significant changes in the economic environment and market conditions. The Company has obtained insurance to mitigate some of this risk. CASH AND CASH EQUIVALENTS - For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with maturities of three months or less on their acquisition date to be cash equivalents. Cash and cash equivalents include cash on hand and funds held in checking, money market, and savings accounts. FEES RECEIVABLE - Fees receivable consist of fees due on loans closed prior to the balance sheet date. Fees receivable are typically collected within 30 days. MORTGAGE LOANS RECEIVABLE HELD-FOR-SALE - Mortgage loans receivable held-for-sale consist of loans made to individuals that are primarily collateralized by residential one to four unit family dwellings. Mortgage loans are recorded at the principal amount outstanding net of deferred origination costs and fees and any premium or discounts. These loans are carried at the lower of amortized cost or fair value as determined by outstanding commitments from investors or current investor-yield requirements, calculated on an aggregate basis. Interest on loans receivable held-for-sale is credited to income as earned. Interest is accrued only if deemed collectible. ALLOWANCE FOR LOAN REPURCHASES AND PREMIUM RECAPTURE - The allowance for loan repurchases and premium recapture relates to expenses incurred due to the potential repurchase of loans or indemnification of losses based on alleged violations of representations and warranties which are customary to the mortgage banking industry. Provisions for losses are charged to gain on sale of loans and credited to the allowance. The allowance represents the Company's estimate of the total losses expected to occur and is considered to be adequate by management based upon the Company's evaluation of the potential exposure related to the loan sale agreements over the life of the associated loans sold. The Company has purchased insurance to cover third party broker fraud, which mitigates some of the risks. OFFICE PROPERTY AND EQUIPMENT, NET - Office property and equipment, net, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the asset as follows: Computer hardware Five years Furniture and fixtures Five to seven years Computer software Three years Leasehold improvements Lower of life of lease or asset F-11 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) AVAILABLE-FOR-SALE SECURITIES AND COMPREHENSIVE LOSS - Securities available-for-sale are carried at fair value with unrealized gains and losses reported in other comprehensive income. Realized gains (losses) on securities available-for-sale are included in other income and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Gains and losses on sales of securities are determined on the specific-identification method. Equity securities held principally for resale in the near term are classified as trading securities and recorded at their fair values. Unrealized gains and losses on trading securities are included in other income. During 2004 and 2003, the Company did not engage in trading securities. Declines in the fair value of individual and available-for-sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. As of December 31, 2004 and 2003, no securities were determined to have other than a temporary decline in fair value below cost. In fiscal 2004 and 2002, the Company had no items of comprehensive loss other than net loss. DERIVATIVES - The Company does not purchase, sell, or utilize off-balance sheet derivative financial instruments or derivative commodity instruments. GOODWILL - Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a purchase business combination. Goodwill and other intangible assets are stated on the basis of cost. See also "Impairment" which follows. IMPAIRMENT - Long-lived assets, including certain identifiable intangibles and goodwill, are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the asset in question may not be recoverable including, but not limited to, a deterioration of profits for a business segment that has long-lived assets, and when other changes occur which might impair recovery of long-lived assets. Management has reviewed the Company's long-lived assets and has recorded an impairment charge of $2,582 in the year ended December 31, 2004 related to its PGNF subsidiary to reduce the carrying value of PGNF to estimated realizable value. The method used to determine the existence of an impairment would be generally by comparing the undiscounted operating cash flows estimated over the remaining useful lives of the related long-lived assets to their related carrying amounts. Impairment is measured as the difference between fair value and unamortized cost at the date impairment is determined. Subsequent to the year ended December 31, 2004, the Company recognized an impairment charge of $822 in connection with the value of goodwill. After the impairment charge, goodwill had a remaining book value of $0 (see Note 17). GAIN ON SALES OF LOANS - Gains or losses resulting from sales of mortgage loans are recognized at the date of settlement and are based on the difference between F-12 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) the selling price of the mortgage loans sold and the carrying value of the related loans sold. Nonrefundable fees and direct costs associated with the origination of mortgage loans are deferred and recognized when the loans are sold. Loan sales are accounted for as sales when control of the loans is surrendered, to the extent that consideration other than beneficial interests in the loans transferred is received in the exchange. ORIGINATION FEES - Origination fees are comprised of points and other fees charged on mortgage loans originated by the retail segment of the Company. Points and fees are primarily a function of the volume of mortgage loans originated by our retail segment. Origination fees on loans originated by the Company that are subsequently sold are deferred and recognized as part of the gain on sale of loans. INCOME TAXES - The Company accounts for income taxes pursuant to Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under the asset and liability method specified thereunder, deferred taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities. Deferred tax liabilities are offset by deferred tax assets relating to net operating loss carryforwards and deductible temporary differences. ADVERTISING - The Company's advertising costs are expensed as incurred. Advertising expense were $20, $60, and $0 for the years ended December 31, 2004, 2003 and 2002 respectively. RECLASSIFICATIONS - Certain reclassifications have been made to the 2003 financial statements in order to conform to the presentation adopted for 2004. These reclassifications had no effect on net income or retained earnings. FAIR VALUE OF FINANCIAL INSTRUMENTS - Financial instruments of the Company consist of cash and cash equivalents, receivables for fees, accounts payable, notes payable, and convertible debentures payable. The carrying amount of financial instruments approximates fair value. CONCENTRATIONS OF RISKS - The Company is required by Statement of Financial Accounting Standards No. 105 to disclose concentrations of credit risk regardless of the degree of such risk. The Company's operations are concentrated in single-family first mortgage residential real estate market. The Company operates in a heavily regulated environment. The operations of the Company are subject to changes in laws, administrative directives and rules and regulations of federal, state, and local governments and regulatory agencies. Such changes may occur with little notice of time for compliance. Further, the Company performs credit evaluations of its customers' financial condition, performs its operations under contracts and requires deposits when deemed necessary. Historically, the Company has not incurred any significant credit losses. The Company originates and processes loans that are closed and immediately assigned to financial institutions or mortgage banking companies throughout Florida, although the majority of PHF's business is in the Central Florida area. The Company closed loans with approximately ten financial institutions or mortgage companies of which only two, Irwin Mortgage and Chase Mortgage, exceeded 10% of the total volume for the years ended December 31, 2004 and 2003. F-13 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) The Company maintains its cash in bank deposit accounts at a high credit-quality financial institution. At times during the years ended December 31, 2004 and 2003, the Company's cash balances exceeded the federally-insured limit. Management believes this policy will not adversely affect the Company. At December 31, 2004 and 2003, cash balances exceeded the federally-insured limit by $0 and $225, respectively. STOCK-BASED COMPENSATION - The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations, in accounting for employee stock options rather than the alternative fair value accounting allowed by FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). APB 25 provides that compensation expense relative to the Company's employee stock options is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Under SFAS 123, the fair value of stock options at the date of grant is recognized in earnings over the vesting period of the options. In December 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS 148"), which amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results. The Company will continue to report stock based compensation under APB 25 but has adopted the interim reporting requirements of SFAS 148. As of December 31, 2004, there were stock options outstanding for the purchase of 34,411,750 shares of the Company's common stock. There were 22,935,000 stock options granted and 29,262,000 forfeited during the year ended December 31, 2004. The following table shows the pro forma net loss as if the fair value method of SFAS No. 123 had been used to account for stock-based compensation expense for the years ended December 31, 2004, 2003 and 2002 (dollars in thousands, except per share amounts):
2004 2003 2002 ---- ---- ---- Net loss from continuing operations, as reported $ (2,358) $(1,680) $(2,342) Stock based employee compensation expense determined under fair value method for all awards, net of related tax effects 521 707 47 ---------------------- --------------------- ---------------------- Proforma net loss from continuing operations $(2,879) $(2,387) $(2,389) ====================== ===================== ====================== Net loss per share from continuing operations: Basic and diluted, as reported $(0.03) $(0.01) $(0.04) ====================== ===================== ====================== Pro forma basic and diluted $(0.03) $(0.02) $(0.04) ====================== ===================== ======================
F-14 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) RECENT ACCOUNTING DEVELOPMENTS - In January 2003, the FASB issued FIN 46(R), "Consolidation of Variable Interest Entities -- an interpretation of ARB No. 51" ("FIN 46(R)"). The objective of this Interpretation is not to restrict the use of variable interest entities but to improve financial reporting by enterprises involved with variable interest entities. FIN 46(R) states that a business enterprise with a controlling financial interest in a variable interest entity should include the assets, liabilities, and results of the activities of the variable interest entity in consolidated financial statements with those of the business enterprise. FIN 46(R) applied immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The adoption of this interpretation has had no effect on the Company's financial statements. On December 12, 2003, the American Institute of Certified Public Accountants issued Statement of Position No. 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" (SOP 03-3). SOP 03-3 requires acquired impaired loans for which it is probable that the investor will be unable to collect all contractually required payments receivable to be recorded at the present value of amounts expected to be received and prohibits carrying over or creation of valuation allowances in the initial accounting for these loans. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. SOP 03-3 does not have an impact on the Company's results of operations or financial condition. In March 2004, Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 105 was issued, which provides guidance regarding loan commitments that are accounted for as derivative instruments under FASB No. 133 (as amended), "Accounting for Derivative Instruments and Hedging Activities". In this Bulletin, the SEC ruled that the amount of the expected servicing rights should not be included when determining the fair value of derivative interest rate lock commitments. This guidance must be applied to rate locks initiated after March 31, 2004. SAB No. 105 has had no impact on our financial condition or results of operations. In March, 2004, the Emerging Issues Task Force (EITF) issued EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-1). EITF 03-1 provides recognition and measurement guidance regarding when impairments of equity and debt securities are considered other-than-temporary thereby requiring a charge to earnings. EITF 03-1 also requires additional annual disclosures for investments in unrealized loss positions. The additional annual disclosure requirements were previously issued F-15 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES (continued) by the EITF in November 2003 and were effective for the year ended December 31, 2003. In September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1, which delays the recognition and measurement provisions of EITF 03-1 pending the issuance of further implementation guidance. EITF 03-1 and EITF 03-1-1 do not have an impact on our results of operations or financial condition. In June 2004, the FASB released EITF 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128" (EITF 03-6). This pronouncement provides guidance on when to apply the two-class method for computing basic and diluted earnings per share for participating securities. A participating security is a security that participates in undistributed earnings with common stock regardless of whether the participation is dependent upon the occurrence of a specific event. EITF 03-6 did not impact the Company's results of operations or financial condition. In December, 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) "Share-based Payment" (SFAS 123R) which eliminates the ability to account for share-based compensation transactions using Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," (APB 25) and generally requires that such transactions be accounted for using a fair value-based method with the resulting compensation cost recognized over the period that the employee is required to provide service in order to receive their compensation. SFAS 123R also amends SFAS No. 95, "Statement of Cash Flows," requiring the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required. The provisions of this statement are effective in the first fiscal beginning after June 15, 2005. The impact of the adoption of SFAS 123 is addressed above (see stock-based compensation) and the impact of adopting SFAS 123R is not expected to be materially different. NOTE 2. DISCONTINUED OPERATIONS On June 30, 2004, we closed the sale of our PGNF Home Lending Corp. ("PGNF") subsidiary effective May 31, 2004. Pursuant to the agreement, the Company exchanged the common stock of PGNF, as well as the assumption of all of PGNF's liabilities, contingent and otherwise, for 52,329,735 shares of our common stock valued at $3,140 (based upon the closing price of $0.06 on May 31, 2004) and 1,800 shares of our Series E preferred stock plus accrued dividend valued at $1,998. In accordance with Statement of Financial Accounting Standards No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets," the assets and liabilities of the PGNF have been classified as discontinued operations, with its operating results in the current and prior periods reported in discontinued operations for the years ended December 31, 2004 and 2003. F-16 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 2. DISCONTINUED OPERATIONS (continued) A summary of the operating results of the discontinued operations for the years ended December 31, 2004 and 2003 is as follows.
2004 2003 ---- ---- Revenue: Gain on sale of loans $ 2,160 $ 7,230 Loan origination fees 551 3,031 Interest, dividends, and other income 546 1,680 ------------------------- ----------------------- Total revenue 3,257 11,941 ------------------------- ----------------------- Expenses: Salaries, commissions, benefits, and stock-based Compensation 2,151 5,914 Loan production costs 310 1,168 General and administrative expenses 1,519 2,989 Impairment of goodwill 2,582 -- Non-recurring expense (income) (198) -- Interest expense 436 1,259 Other (income) expense (4) 46 ------------------------- ----------------------- Total expenses 6,796 11,376 ------------------------- ----------------------- (Loss) income from discontinued operations before provision for income taxes (3,539) 565 Provision for income taxes -- 282 -------------------------- ----------------------- (Loss) income from discontinued operations $ (3,539) $ 283 ========================= =======================
F-17 The following is a summary of the assets and liabilities of our discontinued operations as of December 31, 2003:
ASSETS: Cash and cash equivalents $ 482 Fees receivable 93 Mortgage loans receivable held-for-sale, net 23,245 Office property and equipment, net of accumulated depreciation of $259 1,021 Other notes and mortgages receivable 136 Available-for-sale securities 995 Goodwill 7,814 Prepaid and other assets 260 ----------------------------------- Total assets of discontinued operations $ 34,046 =================================== LIABILITIES: Warehouse lines of credit $ 22,711 Notes payable 1,581 Subordinated note payable - related party 776 Accounts payable 541 Accrued expenses - other 342 Derivative liability 203 ----------------------------------- Total liabilities of discontinued operations $ 26,154 ===================================
F-18 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 3. GOING CONCERN As shown in the accompanying consolidated financial statements, the Company incurred net losses of $5,897 for the year ended December 31, 2004, and cumulative losses of $9,861. At December 31, 2004, we had a working capital deficit of $2,064 and stockholders' deficits of $2,948. These factors raise substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. To remain viable as a going concern, the Company has initiated and executed upon a plan that includes reducing operating expenses, raising additional equity capital, acquiring profitable mortgage brokering operations producing positive cash flow, and renegotiating the terms of its existing indebtedness to reduce their current cash requirements (See Note 16). Though management has accomplished certain aspects of its plan, there can be no assurance that its plan will be successful and the Company will be able to continue as a going concern. NOTE 4. OFFICE PROPERTY AND EQUIPMENT Office property and equipment from continuing operations as of December 31, 2004 and 2003 are summarized as follows:
2004 2003 ---- ---- Furniture and fixtures $ 20 $ 66 Office equipment 87 93 ----------------------------------- ----------------------------------- 107 159 Accumulated depreciation (43) (27) ----------------------------------- ----------------------------------- $ 64 $ 132 =================================== ===================================
Depreciation expense for the years ended December 31, 2004, 2003 and 2002 was $30, $26, and $1 respectively. F-19 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 5. GOODWILL Goodwill represents the excess of the merger consideration over the fair value of the net assets of PHF on January 31, 2003. A summary of goodwill recognized from continuing operations follows: PHF - Consideration for the merger was $876 consisting of $836 in shares of the Company's common stock (1,224,000 shares at approximately $0.6833 per share), $25 in a promissory note issued by the Company, and $15 in costs associated with the merger. At the time of the merger, the fair value of the net assets of PHF was $54. $ 822 Less impairment charge (see below) (822) ----------------------- $ -- ----------------------- Subsequent to the year ended December 31, 2004, the Company recognized an impairment charge of $822 in connection with the value of goodwill. After the impairment charge, goodwill had a remaining book value of $0 (see Note 17). NOTE 6. OTHER ASSETS Other assets from continuing operations at December 31, 2004 and 2003 were: 2004 2003 ---- ---- Deferred tax assets $ -- $ 446 Security deposits and other 3 29 ------------------------ ----------------------- $ 3 $ 475 ======================== ======================= F-20 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 7. DEBT The Company's debt as of December 31, 2004 and 2003 was as follows:
2004 2003 ---- ---- Revolving line of credit subject to a standstill agreement with a commercial bank secured by certain equipment and furniture of the Company bearing interest at prime rate requiring monthly principal reductions of $5 per month, through November 1, 2005 (see below) $ 221 $ 245 Insurance premium finance note bearing an interest rate of 8% with monthly principal and interest payments of $6, due May 1, 2005 24 20 Promissory note to vendor bearing interest of 8% with monthly principal and interest payments of $4, currently past due since October 15, 2004 24 -- Promissory note to shareholders of PHF bearing interest at 4.92%, due December 31, 2005 25 25 Convertible debentures bearing interest at 15%, due December 31, 2004; subsequently modified to mature December 31, 2006 (See Note 16) 379 379 Subordinated note payable to former stockholder bearing interest at 5%, due November 30, 2005, currently in default for current payments due at December 31, 2004 (see Note 16) 480 -- Subordinated note payable to former stockholder bearing interest at 5%, due May 31, 2008, currently in default for current payments due at December 31, 2004 (see Note 16) 1,051 -- --------------- ------------------- $ 2,204 $ 669 =============== ===================
On September 24, 2004, the Company defaulted on its promissory note dated June 4, 2003 to Bank of America, N.A. ("BoA") being unable to repay this note in full when demanded to do so by BoA. BoA has commenced legal action against us and other guarantors of the indebtedness for repayment. On December 13, 2004, we entered into a standstill agreement with BoA whereby, for a principal reduction payment of $25 and the payment of an extension fee and BoA's legal fees, the maturity date of the note was extended to December 1, 2005, the interest rate was increased to the bank's prime rate plus 4%, and requires principal reduction payments of $5 per month through November 1, 2005. F-21 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 7. DEBT (continued) On January 1, 2005, the Company defaulted on its subordinated promissory notes due a formerly related party. These notes represent indebtedness incurred in the divestiture of PGNF. On April 7, 2005, the Company reached an agreement with the holder of the notes whereby the Company would begin making monthly interest payments of approximately $7 on the notes beginning April 2005. The agreement does not include a waiver of rights by the holder. Maturities of debt at December 31, 2004 are as follows: Year Ending Amount ----------- ------ 2005 $ 1,253 2006 100 2007 100 2008 751 ----------------------- Total $ 2,204 ======================= NOTE 8. STOCKHOLDERS' DEFICIENCY PREFERRED STOCK - The Company's certificate of incorporation authorizes a series of 5,000,000 shares of preferred stock with a par value of $0.0001 and with such rights, privileges and preferences, as the board of directors may determine. On March 26, 2003, the Company's board of directors authorized the issuance of 3,000 shares of preferred stock, par value $0.0001 per share, and designated the shares as Series E Preferred Shares (the "Series E Preferred"). The stated value of each share of the Series E Preferred is $1,000 per share; has a mandatory dividend of 4% of the stated value, per annum and shall be payable on January 1st of each year and is payable in either shares of the Company's common stock or cash; has no voting rights; and is not convertible. On March 26, 2003, certain of the Company's executive officers converted certain accrued salary and benefits into 659 shares of Series E Preferred. On March 26, 2003, the holder of the note issued for the PGNF acquisition agreed to convert the note and accrued interest into 1,800 shares of our Series E preferred stock with a face value of $1,000 per share, and a 4% stated dividend payable in cash or shares of common stock, at the Company's option. This series of preferred stock does not provide for redemption and is non- voting. On May 31, 2004, these 1,800 shares were returned to the Company as part of the divestiture of PGNF discussed above (See Notes 1 and 2). STOCK PURCHASE WARRANTS - As part of its convertible notes offering, the Company issued detachable warrants to purchase up to 75,800 shares of common stock at a rate of $0.25 per share. The warrants are exercisable at a rate of $0.25 per share for a period of three years. COMMON STOCK - In March 2002, the Company, partially through its founding shareholders, issued a total of 16,431,975 shares of restricted and unrestricted common stock to its newly recruited chief executive officer in connection with his employment agreement and recorded $200 of non-cash stock compensation applicable to the 5,477,325 of shares that were unrestricted. Immediately prior to their issuance to the new chief executive officer, they had been contributed, at no consideration, to the Company by the Company's two founding shareholders. Of the 10,954,650 restricted shares issued, all of which were newly issued shares, 8,215,875 were to vest over time with the value of the stock award to be F-22 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 8. STOCKHOLDERS' DEFICIENCY (continued) amortized to expense over the related vesting period. The remaining 2,738,775 restricted shares were to vest upon the Company's completing its initial acquisition, with a compensation charge to be recorded based on the market value of the stock at the time of such initial acquisition. On July 16, 2002, this individual resigned as chief executive officer of the Company. In connection with his resignation, he rescinded the stock grant as well as all options that he had been granted. In accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations, the Company recorded approximately $62 of income in order to reverse the effects of amounts previously recorded as expense for the amortization of unvested restricted stock that was forfeited. Also, pursuant to the terms of the rescission agreement, the unrestricted shares that were issued to the individual that had been contributed to the Company by the founding shareholders were reissued to them and pursuant to the merger agreement with PlanetRx.com the restricted shares were reallocated to all shareholders that had existed just prior to the merger with PlanetRx.com. The reallocation to all other shareholders was a "de facto" proportional stock split, not requiring any accounting recognition. The re-issuance of the shares to the founding shareholders resulted in a $548 charge to non-cash stock-based compensation, since among other factors, they assumed the responsibilities of the former executive. In May of 2002, the Company completed an offering of 10,783,486 shares of common stock for approximately $394 to private investors at $0.0365 per share. Approximately $9 of offering costs were charged against these proceeds. Also in May of 2002, as described in Note 1, the Company merged with PlanetRx.com. As a result, the shareholders of PlanetRx.com became shareholders of the Company. At the time of the merger, these shareholders owned 6,173,403 shares. In accordance with standard accounting practices for reverse acquisitions, the shares owned and retained by the PlanetRX.com shareholders are treated as if they were newly issued by the Company to effect the merger. In July 2002 the Company issued 458,725 shares of common stock valued at $0.10 per share, to certain consultants as consideration for their services and recorded $46 of non-cash compensation expense. In November 2002, the Company issued 400,000 shares of common stock, valued at $0.09 per share, to a consultant as consideration for his services and recorded $36 of non-cash compensation expense. STOCK OPTIONS - In December 2002, the Company's shareholders approved the 2002 Equity Participation Plan (the "2002 Plan"). The maximum number of shares of common stock that may be issued pursuant to options or as restricted stock granted under the 2002 Plan is one hundred million shares. The 2002 Plan authorizes the granting of stock options, restricted stock and stock bonuses to employees, officers, directors and consultants, independent contractors and advisors of the Company and its subsidiaries. F-23 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 8. STOCKHOLDERS' DEFICIENCY (continued) Under SFAS 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the years ended December 31, 2004, 2003 and 2002: 2004 2003 2002 ---- ---- ---- Expected life of option 4 4 4 Dividend yield 0% 0% 0% Volatility 136% 37% 115% 3.43% 2 .89% 3.94% Risk free interest rate. The weighted average fair value of options granted to employees, directors and consultants during the years ended December 31, 2004, 2003 and 2002 was as follows: 2004 2003 2002 ---- ---- ---- Fair value of each option granted $ 0.03 $ 0.18 $ nil Total number of options granted 22,935,000 27,609,750 38,433,000 Total fair value of all options granted $ 790 $ 4,852 $ 83 Outstanding options, consisting of ten-year incentive options typically vest and become exercisable over a three-year period from the date of grant. The outstanding options expire ten years from the date of grant or upon retirement from the Company, and their exercise is contingent upon continued employment during the applicable ten-year period. F-24 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 8. STOCKHOLDERS' DEFICIENCY (continued) A summary of the stock option grants outstanding as of December 31, 2004, 2003 and 2002 as well as changes during the years then ended is presented below:
NUMBER OF WEIGHTED OPTIONS AVERAGE -------- EXERCISE PRICE ----- Outstanding at January 1, 2002 -- -- Granted 38,433,000 $ 0.19 Assumed in merger 18,750 $ 2.12 Exercised -- -- Forfeited -- -- ----------------- --------------------- Outstanding at December 31, 2002 38,451,750 $ 0.19 Granted 27,609,750 $ 0.47 Exercised -- -- Rescinded (15,000,000) $ 0.26 Forfeited (10,322,750) $ 0.16 ----------------- --------------------- Outstanding at December 31, 2003 40,738,750 $ 0.37 Granted 22,935,000 $ 0.06 Exercised -- -- Forfeited (29,262,000) $ 0.31 ----------------- --------------------- Outstanding at December 31, 2004 34,411,750 $ 0.21 ================= ===================== Options exercisable at December 31, 2004 10,110,083 $ 0.18 ================= =====================
The following table summarizes information about stock options outstanding at December 31, 2004:
12/31/04 Options Remaining Options Exercisable Life In Exercise Price Range Outstanding ----------- Years -------------------- ----------- ----- $0.04 - $0.05 13,000,000 -- 9.6 $0.09 - $0.10 7,408,000 7,408,000 7.8 $0.17 - $0.26 1,340,000 683,333 8.8 $0.44 - $0.45 12,645,000 2,000,000 8.5 $2.12 * 18,750 18,750 5.8 ----------------- ------------ 34,411,750 10,110,083 ================= ============
* Granted by predecessor issuer F-25 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 9. COMMITMENTS AND CONTINGENCIES Off-Balance Sheet Risks - The Company enters into commitments to extend credit in the normal course of business. These commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Commitments to fund loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. One-to-four family residential properties, if funded, would collateralize the commitments. The Company evaluates each customer's creditworthiness and obtains appraisals to support the value of the underlying collateral. Also, external market forces affect the probability of commitments being exercised; therefore, total commitments outstanding do not necessarily represent future cash requirements. The Company quotes interest rates to borrowers, which are generally subject to change by the Company. Although the Company typically honors such interest rate quotes, the quotes do not constitute interest rate locks, minimizing the potential interest rate risk exposure. The Company had no binding commitments to fund loans at December 31, 2004. Supervisory Regulation - The Company's mortgage brokering business is subject to the rules and regulations of the Department of Housing and Urban Development ("HUD") and various state and federal agencies with respect to originating, processing, and selling mortgage loans as a nonsupervised correspondent lender. Those rules and regulations require, among other things, that the Company's subsidiary, PHF, maintain a minimum net worth of $63. As of December 31, 2004, PHF was in compliance with these requirements. The Company currently does not service loans for other investors or federal agencies. Minimum Operating Lease Commitments - The Company is party to a real estate lease for its Orlando location as well as leases for certain office equipment. The Company pays taxes, insurance, other operating expenses, and general maintenance for all lease arrangements. Rent expense of continuing operations for the years ended December 31, 2004 and 2003 was $163 and $128, respectively, and included facilities rent of $157 and $121, respectively. Equipment rent for the same periods totaled $6 and $7, respectively. The minimum rental commitments for the lease agreement for the Company's premises are as follows: Year ending December 31, 2005 $ 55 2006 23 ----------------------------------- $ 78 ----------------------------------- Litigation - On October 15, 2004, the Company was served with a summons on an eviction action by its landlord seeking unpaid rent and other damages of $268. The Company agrees to vacate the office space it occupied in forgiveness of unpaid rents under the lease and forfeiture of its deposit of $25. Based upon this agreement, the action was dismissed with prejudice. On September 24, 2004, the Company defaulted on its promissory note dated June 4, 2003 to Bank of America, N.A. ("BoA") being unable to repay this note in full when demanded to do so by BoA. BoA has commenced legal action against the Company and other guarantors of the indebtedness for repayment. On December 13, 2004, the Company entered into a standstill agreement whereby, for a principal reduction payment of $25 and the payment of an extension fee and the bank's legal fees, the maturity date of the note was extended to December 1, 2005, the interest rate was increased to the bank's prime rate plus 4%, and requires principal reduction payments of $5 per month through November 1, 2005. F-26 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 9. COMMITMENTS AND CONTINGENCIES (continued) In mid-2001, the Company, and certain of its former directors and officers were named as defendants in class action complaints alleging violations of the federal securities laws in the United States District Court for the Southern District of New York. In mid-2002, the complaints against the Company were consolidated into a single action. The essence of the complaint is that in connection with the Company's initial public offering in October 1999 ("IPO"), the defendants issued and sold the Company's common stock pursuant to a registration statement which did not disclose to investors that certain underwriters in the offering had solicited and received excessive and undisclosed commissions from certain investors acquiring the Company's common stock in connection with the IPO. The complaint also alleges that the registration statement failed to disclose that the underwriters allocated Company shares in the IPO to customers of the underwriters in exchange for the customers' promises to purchase additional shares in the aftermarket at pre-determined prices above the IPO price. The action seeks damages in an unspecified amount. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies that had initial public offerings of securities between 1997 and 2000 same time period. The Company has approved a Memorandum of Understanding ("MOU") and related agreements which set forth the terms of a settlement between the Company, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement contemplated by the MOU provides for a release of the Company and the individual defendants for the conduct alleged in the action to be wrongful. The Company would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. It is anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, the Company does not expect that the settlement will involve any payment by the Company. The MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the Court. The Company cannot opine as to whether or when a settlement will occur or be finalized. Whether or not the settlement is ultimately approved, the Company believes the resolution of this matter will not have a material adverse effect on the Company. The Company is also party to various legal proceedings arising out of the ordinary course of the Company's business. Management believes that any liability with respect to these legal actions, individually or in the aggregate, will not have a material adverse effect on the Company's consolidated financial position and results of operations. F-27 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 10. INCOME TAXES Income tax expense (benefit) from the Company's continuing operations for the years ended December 31, 2004, 2003 and 2002 were as follows:
2004 2003 2002 ---- ---- ---- Current: Federal $--- $(809) $--- State 42 14 --- ---------------------- --------------------- ---------------------- 42 (795) --- ---------------------- --------------------- ---------------------- Deferred: Federal 414 (42) --- State --- --- --- ---------------------- --------------------- ---------------------- 414 (42) --- ---------------------- --------------------- ---------------------- $ 456 $ (837) $--- ====================== ===================== ======================
The components of the Company's net deferred tax assets as of December 31, 2004, and 2003 were as follows: 2004 2003 ----------------- ----------------- Deferred tax assets: Deferred salaries and benefits $ 735 $ 756 Operating loss carryforwards 1,462 1,234 Reserves not currently deductible 14 14 Deferred organization costs 68 103 ----------------- ----------------- 2,279 2,107 Deferred tax valuation allowance (2,263) (1,555) Deferred tax asset, net of valuation allowance 16 552 ----------------- ----------------- Deferred tax liabilities: Property and equipment (16) (106) ----------------- ----------------- $ - 446 ================= ================= F-28 Recognition of deferred tax assets is based on management's belief that it is more likely than not that the tax benefit associated with temporary differences and operating loss carryforwards will be utilized. A valuation allowance is recorded for those deferred tax assets for which it is more likely than not that the realization will not occur (see Note 17). Through December 31, 2002, the Company was considered to be in the development stage and had incurred losses since inception. Due to the uncertainty of future taxable income during its development stage, no future tax benefits were recognized. With the acquisitions completed in 2003, the Company was no longer a development stage enterprise and deferred tax assets and liabilities were recognized for the year ended December 31, 2003. While the Company suffered losses in 2004, in management's opinion, the Company has taken steps to generate future taxable income believed to be sufficient to recognize a portion of the deferred tax assets. Subsequent to the year ended December 31, 2004, we determined to reduce the carrying value of deferred tax assets to $0 by increasing the deferred tax valuation allowance $414 (see Note 17). Our valuation allowance at December 31, 2004, consisted of $1,462 for net operating loss carryforwards, and $735 for deferred salaries and benefits, and $66 for other. As of December 31, 2004, we have federal and state NOLs providing a tax effected benefit of $1,849. The NOLs expire in varying amounts in fiscal years 2022 to 2024. The following reconciles the income tax expense computed at the federal statutory income tax rate to the provision for income taxes recorded in the income statement for the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002 ---- ---- ---- Income tax benefit at statutory federal rate 35.0% (35.0)% 35.0% State and local income tax (benefit), net of federal benefit 3.9% 2.5% 3.5% Effect of non-deductible items 0.1% 3.1% -- Valuation allowance (15.0)% (3.9)% (38.5)% ------------------ -------------- ------------ Effective expense (benefit) rate 24.0% (33.3)% 0.0% ================== ============== ============
F-29 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 11. NON-RECURRING CHARGES During 2004, the Company expensed certain investment banking fees and other costs of $25 associated with a failed financing effort. In 2003, the Company expensed certain amounts that were considered non-recurring, which included severance and employment related expense of $240 and costs related to raising capital of $93. NOTE 12. UNAUDITED QUARTERLY RESULTS Set forth below is certain unaudited quarterly financial data for each of our last eight quarters. The information has been derived from unaudited financial statements that, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary to fairly present such quarterly information in accordance with generally accepted accounting principles. The operating results for any quarter are not necessarily indicative of the results to be expected for any future period.
Year Ended December 31, 2004 in thousands, except per share amount) ------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Revenue $ 582 $ 637 $ 479 $ 336 Total operating expenses $ 1,043 $ 816 $ 549 $ 1,304 Interest expense $ 18 $ 25 $ 41 $ 23 Loss on disposal of segment and assets $ -- $ 102 $ -- $ 15 Loss from continuing operations before provision for income taxes $ (479) $ (306 $ (111) $ (1,462) Net loss $(3,352) $ (972 $ (111 $ (1,462) Basic and diluted loss per share $ (0.03) $ (0.01 $ (0.00 $ (0.03)
In connection with the audit of our financial statements as of and for the year ended December 31, 2003, we recognized an income tax benefit on our net operating loss. We had not recognized such a benefit in our previously reported quarterly information. In the table below, we have allocated this tax benefit to our previously reported quarterly information.
Year Ended December 31, 2003 (in thousands, except per share amount) -------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Revenue $ 270 $ 545 $ 656 $ 493 Total operating expenses $ 571 $ 1,072 $ 1,031 $ 1,392 Interest expense $ 109 $ 100 $ 104 $ 102 Loss from continuing operations $ (410 $ (627) $ (479 $ (1,001) Net loss $ (932 $ (281) $ (84 $ (109) Basic and diluted loss per Share $ (0.01 $ (0.00) $ (0.00 $ (0.00)
F-30 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 13. SEGMENT DATA The Company previously operated in two separate business segments: wholesale and retail. With the disposal of PGNF (See Note 2), the Company is currently operating in one business segment: retail mortgage brokering. NOTE 14. SUPPLEMENTAL CASH FLOW INFORMATION
2004 2003 2002 ----------------- ----------------- ---------------- Supplemental Cash Flow Data: Cash interest received $-- $1,649 $-- Cash interest paid $-- $1,674 $-- Income taxes paid $ 5 $35 $-- ================= ================= ================ Non-cash investing and financing activities: Issuance of stock for settlement of obligations and payment for services rendered $232 $-- $-- Issuance of debentures for legal fees $-- $-- $25 Liabilities assumed in reverse acquisition $-- $-- $72 ================= ================= ================ Acquisitions of businesses, net of cash acquired: Fair value of assets acquired $-- $ 26,931 $-- Goodwill $-- $ 8,636 $-- Liabilities assumed $-- $ (26,761) $-- Note issued $-- $ (1,800) $-- Stock issued $-- $ (7,203) $-- ----------------- ----------------- ---------------- Cash acquired in purchases of businesses $-- $ 197 $-- ================= ================= ================
NOTE 15. OTHER RELATED PARTY TRANSACTIONS The Company has entered into employment agreements with certain of its current and former executive officers. These executive officers had elected to defer receipt of the salaries, related benefits and other items due them pursuant to such contracts until the Company acquired sufficient operating capital through the acquisition of operating companies, raising of debt or equity capital or both. At December 31, 2002, the Company had accrued $666 pursuant to these contracts. Subsequent to December 31, 2002, the Company's executive officers converted $659 of such accrued compensation due to them to newly issued preferred shares. (See Note 8). Another minority stockholder provided services to the Company at no cost in August of 2002. These services have been valued at $5 and are included in operating expenses with an offsetting credit to paid-in capital. At December 31, 2004, promissory notes payable in the amount of $25 were outstanding from the acquisition of PHF, bearing an interest rate of 4.92%, payable December 31, 2005. F-31 PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share amounts) NOTE 16. SUBSEQUENT EVENTS On January 19, 2005, the Company completed the acquisition of First Charleston Mortgage, LLC, a privately held South Carolina limited liability company ("FCM"), pursuant to the terms and conditions of a Member Purchase Agreement dated January 19, 2005 (the "Purchase Agreement") among us, FCM and all of the members of FCM. Pursuant to the Purchase Agreement, the Company acquired all of the members' interests of FCM for 4,285,714 shares of its common stock, valued at $214 based upon the closing price of $0.05 on January 19, 2005. The actual value of FCM is subject to earnout and minimum future earnings provisions as specified in the Purchase Agreement. All members also entered into non-competition agreements with the Company. On February 28, 2005, the Company completed a private placement financing transaction pursuant to which it sold 17,207,791 units (at $0.0308 per unit) to several accredited investors for an aggregate purchase price of $530. Each unit consisted of one share of common stock, par value $0.0001 per share (the "Common Stock"), and one warrant to purchase one share of Common Stock at $0.04 per share expiring on December 31, 2007. On January 1, 2005, the Company defaulted on its subordinated promissory notes due a formerly related party. These notes represent indebtedness incurred in the divestiture of PGNF. On April 7, 2005, the Company reached an agreement with the holder of the notes whereby the Company would begin making monthly interest payments on the notes beginning April 2005. The agreement does not include a waiver of rights by the holder. On January 1, 2005, the Company defaulted on its 15% convertible debentures due December 31, 2004. The Company has subsequently repaid principal of $40 to certain holders of its 15% convertible debentures, and holders of $309 of the convertible debentures have agreed to amend the maturity date of the convertible debentures to December 31, 2006 and reduce the interest rate on the debentures to 10% in consideration for a reduction in the strike price of the warrants to $0.05 per share. The convertible debentures require quarterly interest payments on March 31, June 30, September 30, and December 31 of each year. On February 28, 2005, certain of our former executives and current shareholders agreed in principal to convert amount currently due them into additional shares of our Series E Preferred Stock. The stated value of each share of the Series E Preferred is $1,000 per share; has a mandatory dividend of 4% of the stated value, per annum and shall be payable on January 1st of each year and is payable in either shares of the Company's common stock or cash; has no voting rights; and is not convertible. NOTE 17. RESTATEMENT In connection with a Comment Letter received by the Company in 2006, the Company determined that the consolidated financial statements for the year ended December 31, 2004 should be revised in light of such comment letter and changes in the Company's operational activities subsequent to December 31, 2004. As a result, the Company took an impairment charge of $822 in connection with the value of its goodwill, and adjusted its deferred tax assets through an increase in the deferred tax valuation allowance of an additional $414, leaving the carrying value of deferred tax assets at $0. Both the net loss for 2004 and stockholders' deficiency as of December 31, 2004 were increased by $1,236. Accordingly, total consolidated assets at December 31, 2004 were reduced by $1,236. As a result, we are restating our previously issued consolidated balance sheet as of December 31, 2004, and the consolidated statements of operations, comprehensive loss, cash flows, and stockholders' deficiency for the year ended December 31, 2004, and the related footnotes thereto, principally Notes 1, 5, and 10 1, 5, and 10. F-32 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Paragon Financial Corporation (KNA New Market Latin America, Inc.) /s/Aubrey Brown -------------- Aubrey Brown, Chief Executive Officer Dated: October 7, 2008 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/Aubrey Brown Chief Executive Officer October 7, 2008 --------------- Aubtey Brown /s/ Philip Verges Director October 7, 2008 ----------------- Philip Verges /s/Philip J. Rauch Chief Financial Officer October 7, 2008 ------------------ Philip J. Rauch